15/5/2014: Jobs & Employment: Lot Done, More to Do, Still

The is an unedited version of my Sunday Times article from April 27.



As cooperative organisations go, Paris-based OECD is one of the more effective ones. Its regular assessments of member states economic policies and performance drill into various sectors and often flash light into the darker corners of policy formation and implementation that are often untouched by the likes of the IMF, the central banks and the EU Commission.

Good example is the OECD’s third annual review of Ireland's Action Plan for Jobs, published this week.

The review starts by highlighting the positive achievements to-date set against the Action Plan targets and the realities of the unemployment crisis we face.

After hitting the bottom of the Great Recession, Irish labour markets have recorded a rebound in 2013. As the result of the robust jobs creation in the economy, Irish employment levels rose by around 60,000 in 12 months through Q4 2013. New jobs additions were broadly based across various sectors and predominantly concentrated in full-time employment segment. All of which is the good news.

Being a diplomatic, politically correct body, the OECD does not question the aggregate numbers of new jobs recorded. As this column noted on numerous occasions before, the 60,000 figure includes a large number of jobs in agriculture – a number that generates more questions than answers. But from the point of view of the OECD and indeed the Irish Governments 2012 Action Plan for Jobs, quality is a distant goal, while quantity is the primary objective. By this metric, as OECD notes, Ireland is now well on track to deliver on the interim target of 100,000 new jobs by 2016.

Still, accolades aside, Irish non-agricultural employment is lingering at 39 percent of total population – implying a dependency ratio that is comparable with that seen in the late 1990s. Official unemployment counts are around 253,000 and factoring in those in State training programmes the number rises to over 330,000. 16 percent of our total Potential Labour Force is currently not in employment. A things get even scarier when we add all people searching for jobs, underemployed, unemployed that have been discouraged from looking for work, those in State training programmes and the net emigration of working age adults. By this metric, the broadest joblessness rate in the country stands at around 32 percent.

Unlike the Government, faced with the above numbers, the OECD recognises that the Action Plan target of 100,000 new jobs by 2016 is a reflection of our public culture of low aspirations. "While Irish policymakers can take some satisfaction in the economy’s return to growth and recent robust job growth, significant challenges lie ahead if the country is to rapidly bring down the unemployment rate," said report authors. Anodyne a statement for you and me this screams a serious warning to the Government in OECD’s language.

There are legitimate concerns and uncertainties about the pace of the labour market recovery. At peak of employment in Q3 2007, there were 2.17 million people working in our economy. At the bottom of the Great Recession, in Q1 2012 that number fell to 1.825 million. In Q4 2013 the number employed was 1.91 million or 76,000 above the trough, but almost 260,000 below the peak. Meanwhile, Irish working age population has grown by some 93,700 despite large net outflows due to emigration. In other words, jobs creation to date has not been enough to fully compensate for demographic changes in working age population.

Beyond headline unemployment numbers, Ireland is facing a huge crisis of long-term joblessness, the crisis that was recently covered in depth by this column. With it, there is a significant risk that improved jobs creation in the future is not going to provide employment for those out of work for more than a year.

While reversing emigration and accommodating for growing population will require much higher rate of new employment growth than we currently deliver, the Government’s Medium Term Economic Strategy published this year is aiming to bring employment levels to 2.1 million in by 2020. This means thirteen years after the on-set of the crisis our employment is expected to still fall short of the pre-crisis peak.


Which begs a question: who will be the unemployed of tomorrow?

OECD is rather serious on this subject. "Tackling unemployment and ensuring that high cyclical unemployment does not become structural and persistent are important challenges. A relentless focus on activating those most vulnerable to alienation from the labour market will be even more important than aggregate job creation targets in this regard."

In other words, according to the OECD, long-term unemployed, youth out of jobs and out of education, as well as those with low skills and of advanced working age are at a risk of becoming structurally (re: permanently) unemployed, even if the Government targets under all existent strategies are met.

Much of this stems from the sectoral breakdown of jobs being created and types of jobs that are growing in demand in modern workplace.

For example, the OECD praises the Government for focusing Action Plan "on private sector-led, export-oriented job creation by getting framework conditions right and continually upgrading the business environment". But export-led growth is not going to do much for our high levels of long-term unemployment. Jobs creation in exporting sectors is directly linked to modern skills sets and high quality of human capital. Long-term unemployment is linked to lower skills and/or past skills in specific sectors, such as construction. To make a dent in an army of long-term jobless we need domestic growth. To make this growth sustainable, we need productivity enhancements in domestic sectors and SMEs that require employment of higher skills in these sectors. There is a basic contradiction inherent in these two drivers of recovery: skills in supply within the pool of long-term unemployed are not matched to skills in demand within the modernising economy.

Something has to be done to address this dichotomy.

Under various policy reforms enacted during the crisis, Ireland witnessed introduction of significant changes to the benefits system, employment programmes, as well as reduced levels and duration of unemployment insurance cover. In addition, the Government used restructuring of training programmes to introduce a new concept of one-stop support centres, Intreo, which are being rolled out across the country. All of this is in line with previous OECD and Troika recommendations and much of it is needed.

But, as OECD notes, six years into the crisis, more remains to be done.

The OECD identifies Government's flagship activation programme, JobBridge as "large and expensive" and insufficiently targeted to help the most disadvantaged groups. In other words, JobBridge has became a synonym for unpaid apprenticeship for recent graduates instead of being a stepping stone from unemployment to a job requiring moderate re-skilling. OECD also highlights the risk of State training programmes effectively delaying job searches by the unemployed or reducing their job search efforts.

Beyond the above, the OECD points to the risk that the longer-term and lower-skilled unemployed may fall outside the resources and remit cover of the new agencies - the SOLAS and the Intreo.

With all reforms to-date, the OECD highlights the lack of willingness on behalf of the Government to rationalise some of the labour market programmes, even where there is clear and available evidence of their low effectiveness.

One example is the long-established Community Employment Programme (CEP), which accounts for a full one third of all spending on activation programmes. Data available to the Government strongly shows that CEP is not cost-effective and has a spotted track record in terms of securing the participants return to regular employment. Instead of the CEP, the Irish state should focus resources on developing a modern apprenticeship programme that can replace existent ineffective schemes. This focus on market skills-based training available under the apprenticeship system, supported by the OECD report, is in line with policy suggestions presented in this column in the recent past and with the Entrepreneurship Forum report published last year.


The OECD report also provides a detailed analysis of the institutional reforms that are needed to deliver sustainable jobs creation in Ireland in line with the Government agenda. There is a need to mobilise employers to engage with the Government programmes to develop employment and skills systems that can address future demands in the real economy. Instead of craft-focused and manual professions-oriented training, Ireland needs more MNCs and SMEs-driven skills acquisition and upgrading programmes.

The OECD also stresses the need for stimulating productivity growth by developing more skills-intensive domestic sectors. Unlike the Irish authorities, the OECD is painfully aware that aggregate productivity growth, jobs creation and skills development must be anchored to indigenous sectors and enterprise, including the SMEs, and not be relegated to the domain of the SMEs and exports-oriented producers alone.


In all of this, the report highlights a major bottleneck in the Irish human capital development systems – dire lack of training and up-skilling programmes available to SMEs and early stage companies that are capable of supplying skills that are in actual demand in the markets and that can simultaneously drive forward productivity growth and innovation in Irish enterprises.

Slightly paraphrasing Fianna Fail’s GE2002 posters: in the case of Government delivery on jobs and unemployment, “A lot done. Even more to do.”

Note: PLS1 indicator is unemployed persons plus discouraged workers as a percentage of the Labour Force plus discouraged workers.  

PLS3 indicator is unemployed persons plus Potential Additional Labour Force plus others who want a job, who are not available and not seeking for reasons other than being in education or training 



Box-out:

Since the early days of the EU, one of the most compelling arguments in support of the common European currency was the alleged need for eliminating the volatility in the exchange rates. It remains the same today. High uncertainty in the currency markets, the argument goes, acts to depress international trade and distorts incentives to transact across borders. Alas, theory aside, the modern history puts into doubt the validity of this argument. During the 1990s, prior to the creation of the euro, Irish current account surpluses averaged 1.9 percent of GDP just as the economy was going through a period of rapid accumulation of capital - a process that tends to put pressure on current account balance. Still, in the decade before the euro introduction, Ireland's external balance ranked fifth in the European Economic Area. During the first decade of the euro, owing to the massive credit bubble, Irish current account balance collapsed to an annual average of -2.3 percent of GDP. Since hitting the bottom of the crisis, our performance rebound saw current account swinging to an average annual surplus of 7 percent. Alas, this reversal of fortunes ranks us only 7th in the EEA. In fact, since 2000 through today, non-euro area economies of Denmark, Sweden, Switzerland have consistently outperformed Ireland in terms of current account surpluses. Cumulatively Swiss economy generated external balances of 135 percent of GDP between 2001 and 2013, Swedish economy 88 percent and Danish economy 51 percent of GDP. Irish cumulated current account balance over that period is a deficit of 9 percent of GDP. Let's put the matters into perspective: between 1990 and 1999 Irish economy generated a total surplus of USD12.5 billion. Since the introduction of the euro, our cumulated current account deficit stands at USD23.5 billion. At current blistering rates of current account surpluses, it will take us another five years to achieve a current account balance across the entire period of 30 years. Meanwhile, deprived of the alleged benefits of currency stabilisation, Denmark accumulated curret account surpluses of USD149 billion between 2001 and the end of 2013, Sweden USD378 billion and Switzerland USD645 billion. The euro might be a good idea for a political union or for PR and advertising agencies spinning its alleged benefits to European voters, but it has not been all too kind to our own trade balances.






21/2/2014: Homeownership, Negative Equity, Entrepreneurship: Data from France

Over recent years I wrote extensively about the issues of negative equity and the costs of this phenomena to the society and economy at large. Much of the research in this areas focuses on the US data, with some departures for German and Italian data sets. Here is a recent paper using French data and dealing with the issue of housing collateral (house prices-linked borrowing constraints) and entrepreneurship.

"HOUSING COLLATERAL AND ENTREPRENEURSHIP" by Martin C. Schmalz, David A. Sraer, David Thesmar (Working Paper 19680 http://www.nber.org/papers/w19680) provides evidence on whether entrepreneurs "face credit constraints, which restrict firm creation, post-entry growth, and survival, even over the long run. The existing literature documents a strong correlation between entrepreneurial wealth and the propensity to start or keep a business (Evans and Jovanovic, 1989; Evans and Leighton, 1989; Holtz-Eakin et al., 1993)."

The problem is that there is still "a considerable debate …about whether such a correlation constitutes evidence of financial constraints. For instance, individuals who experience a wealth shock, through personal accumulation or inheritance, may also experience an expansion of business opportunities for reasons unrelated to their wealth (Hurst and Lusardi, 2004)."

The authors used "variations in local house prices, combined with micro-level data on home ownership by entrepreneurs. …We compare entrepreneurial outcomes of entrepreneurs owning a house and entrepreneurs renting a house, and compare this difference across geographic regions with different house price dynamics. The comparison between owners and non-owners allows us to filter out local economic shocks that may drive the creation, growth, and survival of local businesses." Do note the important aspect of this data set - by controlling for home ownership v renters, the paper also allows us to look at the potential benefits of the former or the latter in terms of entrepreneurship.

"We investigate both the extensive and intensive margin of entrepreneurship, that is, entry decisions as well as post-entry growth. Our investigation starts with firm growth and survival, conditional on entry. We construct a large cross section of French entrepreneurs starting a businesses in 1998. Combining survey data and administrative data, we are able to observe a variety of personal characteristics, in particular, the home location of the entrepreneurs, as well as their home-ownership status. We match this information to firm-level accounting data of the newly created firms for up to eight years following creation."

Now for the results: 

• "We find that in regions with greater house price growth in the 1990s, firms started by homeowners in 1998 are significantly larger and more likely to survive than firms started by renters." Oops, for the folks saying that homeownership should not be encouraged or incentivised. "In other words, the difference in the size of businesses created by owners and renters is larger in regions in which house prices have appreciated more in the past five years. 
• This effect is robust to controlling for a large set of entrepreneurial characteristics. It is also persistent: in 2005, firms started by entrepreneurs with lower collateral values in 1998 remain significantly smaller in terms of assets, sales, employment, or value added. 
• Finally, this effect is economically large: going from the 25th to the 75th percentile of house price growth in the five years preceding creation allows homeowners to create firms that are 6.5% larger in terms of total assets."
• "We then verify how collateral shocks affect the probability of starting a business, that is, the extensive margin of entrepreneurship. …We find that homeowners located in regions where house prices appreciate more are significantly more likely to create businesses, relative to renters located in the same regions. In other words, the difference between owners and renters in the propensity to start a business is larger in regions in which house prices appreciated more in the past. 
• Again, the effects are economically sizable. Going from the 25th to the 75th percentile of past house price growth increases the probability of firm creation by homeowners, relative to renters, by 9% in our preferred specification."
• More to the above: "We confirm the importance of this result in the aggregate: total firm creation at the regional level is more correlated with house prices in regions where the fraction of homeowners is larger."

As an aside, consider also the following discussion from the paper: The link between funding of start ups and wealth constraints is non-trivial. "Robb and Robinson (2013) document that debt is a large source of financing for start-ups (approximately 44%) and that its availability is related to the scarcity —and therefore the value— of real estate collateral. Hurst and Lusardi (2004) and Adelino et al. (2013) are closest to our paper, because they also investigate the role of housing wealth on firm creation."

However, the latest paper "makes two significant advances relative to these papers:

1. the information on individual homeownership allows us to control for local economic shocks that might create a spurious correlation between entrepreneurial rate and local house prices, and 
2. the nature of our data allows us to track not only firm creation (the extensive margin), but also post-entry growth and survival over a long horizon (the intensive margin)."

"Several earlier papers focus on the role of inheritance shocks to firm quality and survival. Holtz-Eakin et al. (1993) find that firms started after a large inheritance are more likely to survive, a finding they interpret as evidence of credit constraints. By contrast, using Danish data, Andersen and Nielsen (2011) find that businesses started following a large inheritance have lower performance. This finding suggests the relationship between wealth and entrepreneurship may be driven by private benefits of control, or in other words, that business ownership has a luxury-good component (Hurst and Lusardi, 2004). The relation between wealth shocks and post-entry growth/survival thus remains an open discussion."

The latest paper "contributes to this debate by looking at wealth shocks generated by local variations in house prices for homeowners. Arguably, these shocks are much less likely to be correlated with the unobserved heterogeneity in entrepreneurial outcome than inheritance shocks."

"Fracassi et al. (2012) also provide a clean identification on the role credit constraints play small business survival, by exploiting a discontinuity in the attribution of loans to start-ups at a small local bank. In a similar vein, Black and Strahan (2002) find that banking deregulations in U.S. states led to a large increase in firm creations. Whereas these papers focus on the effect credit supply on firm creation and survival, our paper focuses on credit demand via the supply of collateral."

There is an intuitive link between the above forces: "When house prices increase, firms and households have more collateral to pledge, which raises borrowing capacity. On the credit-supply size, banks, balance sheets become stronger, which allows them to lend more. Recent papers have documented the link between house prices and household borrowing and consumption (Mian et al., 2011; Gan, 2010), the link between real estate prices and corporate investment (Gan, 2007a; Chaney et al., 2012), and the link between real estate bubbles and bank lending (Gan, 2007b)."

And the conclusion is: "Our paper shows that entrepreneurial activity also strongly reacts to changes in the value of collateral available to potential entrepreneurs."

So back to that 'negative equity only matters for those who want to move from their current house' meme that Irish economists and policymakers keep pushing around… My suggestion: go back to study economics, folks.

31/12/2013: Negative equity and entrepreneurship: new evidence

Since the beginning of the crisis, I have written about and presented on the topic of negative equity and its adverse effects on economy and society.

Some of the earlier links on this topic can be found here:
http://trueeconomics.blogspot.ie/2010/06/15062010-negative-equity-1.html
http://trueeconomics.blogspot.ie/2010/06/economics-15062010-negative-equity-2.html
http://trueeconomics.blogspot.ie/2010/06/economics-15062010-negative-equity-3.html

One significant adverse effect of negative equity relates to the impact it has (via investment constraints) on entrepreneurship: http://trueeconomics.blogspot.ie/2010/01/economics-15012010-negative-equity.html

This month, NBER published yet another study on the above topic, covering the issue of property values impact on collateral availability for entrepreneurial activities.

The study, "Housing Collateral and Entrepreneurship" (NBER Working Paper No. w19680) by Martin Schmalz, David Alexandre Spaer and David Thesmar "shows that collateral constraints restrict entrepreneurial activity. Our empirical strategy uses variations in local house prices as shocks to the value of collateral available to individuals owning a house and controls for local demand shocks by comparing entrepreneurial activity of homeowners and renters operating in the same region. We find that an increase in collateral value leads to a higher probability of becoming an entrepreneur."

What is novel to the study results and is also extremely important from economic policy point of view is that "Conditional on entry, entrepreneurs with access to more valuable collateral create larger firms and more value added, and are more likely to survive, even in the long run."

Now, keep in mind - Ireland's politicians and both the previous and current Government officials have been consistently claiming that negative equity only matters when households need to move from their current location to a new residence. In contrast, I have asserted from the start of the crisis that the adverse effects of negative equity are present not only in the context of households moving locations, but also for the households that are staying in their current location and that some of the effects are completely independent from the ability of the households to fund their current mortgages.

Link to the study: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2360948

26/12/2013: Don't Bank on the Banking Union: Sunday Times, December 15

This is an unedited version of my Sunday Times column from December 15, 2013.


Over the last week, domestic news horizon was flooded by the warm sunshine of Ireland's exit from the Bailout. And, given the rest of the Euro area periphery performance to-date, the kindness of strangers was deserved.
Spain is also exiting a bailout, and the country is out of the recession, officially, like us. But it took a much smaller, banks-only, assistance package. And, being a ‘bad boy’ in the proverbial classroom, it talked back at the Troika and played some populist tunes of defiance. Portugal is out of the official recession, but the country is scheduled to exit its bailout only in mid-2014, having gone into it after Ireland. No glory for those coming second. Greece and Cyprus are at the bottom of the Depression canyon, with little change to their misery.

In short, Ireland deserves a pat on the back for not being the worst basket case of the already rotten lot. And for not rocking the boat. Irish Government talks tough at home, but it is largely clawless vis-à-vis the Troika. Our only moments of defiance in dealing with the bailout came whenever we were asked to implement reforms threatening powerful domestic interests, such as protected sectors and professions.

However, with all the celebratory speeches and toasts around, two matters are worth considering within the broader context of this week's events. The first one is the road travelled. The second is the road that awaits us ahead. Both will shape the risks we are likely to face in the medium-term future.


The road that led us to this week's events was an arduous one. Pressured by the twin and interconnected crises - the implosion of our banking sector and the collapse of our domestic economy - we fell into the bailout having burnt through tens of billions of State reserves and having exhausted our borrowing capacity. The crater left behind by the collapsing economy was deep: from 2008 through today, Irish GDP per capita shrunk 16.7 percent, making our recession second deepest in the euro area after Greece. This collapse would have been more benign were it not for the banking crisis. In the context of us exiting the bailout, the lesson to be learned is that the twin banking and growth crises require more resources than even a fiscally healthy state can afford. Today, unlike in 2008, we have no spare resources left to deal with the risk of the adverse twin growth and banking shocks.

Yet, forward outlook for Ireland suggests that such shocks are receding, but remain material.

Our economic recovery is still fragile and subject to adverse risks present domestically and abroad. On domestic side, growth in consumer demand and private investment is lacking. Deleveraging of households and businesses is still ongoing. Constrained credit supply is yet to be addressed. This process can take years, as the banks face shallower demand for loans from lower risk borrowers and sharply higher demand for loans from risky businesses. On top of this, banks are deleveraging their own balance sheets. In general, Irish companies are more dependent on banks credit than their euro area competitors. Absent credit growth, there will be no sustained growth in this economy. Meanwhile, structural reforms are years away from yielding tangible benefits. This is primarily due to the fact that we are yet to adopt such reforms, having spent the last five years in continued avoidance of the problems in the state-controlled and protected domestic sectors.

On the Government side, Budgets 2015 and 2016 will likely require additional, new revenue and cost containment measures. Post 2016, we will face the dilemma of compensating for the unwinding of the Haddington Road Agreement on wages inflation moderation in the public sector and hiring freezes.
To-date, Irish economy was kept afloat by the externally trading services exporters, or put in more simple terms - web-based multinationals. Manufacturing exports are now shrinking, although much of this shrinkage is driven by one sector: pharmaceuticals.

Meanwhile, the banking sector is still carrying big risks. Heavy problems of non-performing loans on legacy mortgages side, unsecured household credit and non-financial corporates are not about to disappear overnight. Even if banks comply with the Central Bank targets on mortgages arrears resolution, it will take at least 18-24 months for the full extent of losses to become visible. Working these losses off the balance sheets will take even longer.
Overall, even modest growth rates, set out in the budget and Troika projections for 2014-2018, cannot be taken for granted.


This week, the ongoing saga of the emerging European Banking Union made the twin risks to banks and growth ever-more important. The ECOFIN meetings are tasked with shaping the Bank Recovery and Resolution Directive, or BRRD. These made it clear that Europe is heading for a banking crisis resolution system based on a well-defined sequencing of measures. First, national resources will be used in the case of any banks' failures, including in systemic crises. These resources include: wiping out equity holders, and imposing partial losses on lenders and depositors. Thereafter, national funds can be used to cover the capital shortfalls and liquidity shortages. Only after these resources are exhausted will the EU funds kick in to cover the residual capital shortfalls. This insurance cover will not be in the form of debt-free cash. Instead, the funding is likely to involve lending to the Government and to the banks under a State guarantee.

When you run through the benchmark levels of capital shocks that could qualify a banking system for the euro-wide resolution funding under the BRRD, it becomes pretty clear that the mechanism is toothless. For example, in the case of our own crisis, haircuts on bondholders under the proposed rules could have saved us around EUR15-17 billion. In exchange, these savings would have required bailing in depositors with funds in excess of the state guarantee. It is unlikely that we could have secured any joint EU funding outside the Troika deal. Our debt levels would have been lower, but not because of the help from Europe.

This last point was made very clear to us by this week’s events. After all, our historically unprecedented crisis has now been 'successfully resolved' according to the EFSF statement, and as confirmed by the European and Irish officials. The 2008-2010 meltdown of the Irish financial system was dealt with without the need for the Banking Union or its Single Resolution Mechanism.

With a Banking Union or without, given the current state of the Exchequer balance sheet, the buck in the next crisis or in the next iteration of the current crisis will have to stop at the depositors bail-ins. In other words, banking union rhetoric aside, the only hope any banking system in Europe has at avoiding the fate of Cyprus is that the next crisis will not happen.


Second issue relates to the continued reliance across the euro area banks on government bonds as core asset underpinning the financial system. In brief, during the crisis, euro area banks have accumulated huge exposures to sovereign bonds. This allowed the Governments to dramatically reduce the cost of borrowing: the ECB pushed up bonds prices with lower interest rates and unlimited lending against these bonds as risk-free collateral.

The problem is that, unless the ECB is willing to run these liquidity supply schemes permanently, the free lunch is going to end one day. When this happens, the interest rates will rise. Two things will happen in response: value of the bonds will fall and yields on Government debt will rise. The banks will face declines in their assets values, while simultaneously struggling to replace cheap ECB funding with more expensive market funds.

Given that European Governments must roll over significant amounts of bonds over the next 10 years, these risks can pressure Government interest costs. Simple arithmetic says that a country with 122 percent debt/GDP ratio (call it Ireland) and debt financing cost of 4.1 percent per annum spends around 5 percent of its GDP every year on interest bills, inclusive of rolling over costs. If yield rises by a third, the cost of interest rises to closer to 6.6 percent of GDP. Now, suppose that the Government in this economy collects taxes and other receipts amounting to around 40 percent of GDP. This means that just to cover the increase in its interest bill without raising taxes or cutting spending, the Government will need nominal GDP growth of 3.9 percent per annum. That is the exact rate projected by the IMF for Ireland for 2014-2018. Should we fail to deliver on it, our debts will rise. Should interest rates rise by more than one-third from the current crisis-period lows, our debts will rise.


The point is that the dilemmas of our dysfunctional monetary policy and insufficient banking crisis resolution systems are not academic. Instead they are real. And so are the risks we face at the economy level and in the banking sector. Currently, European financial systems have been redrawn to contain financial exposures within national borders. The key signs of this are diverged bond yields across Europe, and wide interest rates differentials for loans to the real economy. In more simple terms, courtesy of dysfunctional policymaking during the crisis, Irish SMEs today pay higher interest rates on loans compared to, say, German SMEs of similar quality.

Banking Union should be a solution to this problem – re-launching credit flowing across the borders once again. It will not deliver on this as long as there are no fully-funded, secure and transparent plans for debt mutualisation across the European banking sector.

Box-out:

Recent data from the EU Commission shows that in 2011-2012, European institutions enacted 3,861 new business-related laws. Meanwhile, according to the World Bank, average cost of starting a business in Europe runs at EUR 2,285, against EUR 158 in Canada and EUR 664 in the US. Not surprisingly, under the burden of growing regulations and high costs, European rates of entrepreneurship, as measured by the proportion of start up firms in total number of registered companies, is falling year on year. This trend is present in the crisis-hit economies of the periphery and in the likes of Austria, Germany and Finland, who weathered the economic recession relatively well. The density of start-ups is rising in Australia, Canada, the US and across Asia-Pacific and Latin America. In 2014 rankings by the World Bank, the highest ranked euro area country, Finland, occupies 12th place in the world in terms of ease of doing business. Second highest ranked euro area economy is Ireland (15th). This completes the list of advanced euro area economies ranked in top 20 worldwide. Start ups and smaller enterprises play a pivotal role in creating jobs and developing skills base within a modern economy. The EU can do more good in combatting unemployment by addressing the problem of regulatory and cost burdens we impose on entrepreneurs and businesses than by pumping out more subsidies for jobs creation and training schemes.

5/12/2013: Entrepreneurship Culture and Policies in Ireland: Sunday Times, December 1

This is an unedited version of my Sunday Times column from December 1, 2013.


According to Shutterfly CEO and veteran entrepreneur, Jeff Housenbold, “Entrepreneurship is a state of mind”.

While measuring the extent and quality of entrepreneurship in any economy is a tricky task, Ireland is an economy with two conflicting states of mind when it comes to start-ups. On the one hand, we have the official story of an entrepreneurship-rich nation. On the other hand, there is the hard data painting a more complex picture.

The latest Global Entrepreneurship Monitor Report, published earlier this year, ranks Ireland 14th out of 22 EU states surveyed in terms of the opportunities open to the entrepreneurs. We ranked at the bottom of the EU in the share of population with entrepreneurial intentions and 17th in terms of our population perception of entrepreneurship as a viable career option. In contrast, Ireland ranks second highest in the EU in terms of media attention given to the start-ups and in terms of the positive public image of entrepreneurship.

To put it simply, the Monitor data reveals the vast chasm between the media and political cultures promoting Ireland as an entrepreneurship haven, and the realities of running and growing a real start-up venture here.

This chasm was back in the spotlight over the last two weeks.

Last week, the Wall Street Journal published the results of a study that put Ireland in the first place in Europe in terms of venture capital raised in the tech sector over the period from Q1 2003 through Q3 2013. All in, Ireland-based tech start-ups and SMEs raised some USD278.73 per capita on average. This compared to the USD68.39 raised across the European Free Trade Association (EFTA) group of 32 states. Impressive as the number for Ireland was, it still falls short of the US figure of USD660.41 and Israel’s USD1,092.52.

Much of Irish media reported the results as being indicative of Ireland’s high success in entrepreneurship. Alas, the study simply does not support such a conclusion for three reasons. Firstly, the data covers only Venture Capital funding extended to tech sector firms. As the result, it excludes the vast majority of start-ups in the economy that are either operating outside the tech sector, or raising funding through channels other than VCs, or both. Currently, VCs-funded companies in Ireland employ around 9,000 people. This a drop in a bucket, given that there are 84,700 self-employed people with paid employees (just one group of entrepreneurs) in the country. The study also covers deals involving already established firms. Lastly, the study suggests that the banking crisis, resulting in the complete drying up of new lending, could have contributed to increased demand for VC funds.

No one in the mainstream media noticed that less than two months ago, in its submission for Budget 2014, Irish Venture Capital Association (IVCA) said that “the shortage of entrepreneurs [in Ireland] has reached crisis levels”. Per IVCA, in 2011 only “8.5 percent of people in Ireland aspired to be an entrepreneur, down from a high of 12.5 percent in 2005.” The EU average in 2011 was 15.3 percent.

And no one bothered to cross check the results of the Wall Street Journal study with actual data on new enterprise creation in Ireland. According to the latest data from the World Bank, Ireland ranks seventh in the EFTA in the scope of entrepreneurship in overall economy. World Bank groups Ireland alongside with Russia, Romania, Hungary, Slovak Republic and Lithuania in terms of the rates of new enterprise formation.

Another piece of evidence on the gap between realities and perceptions of Irish entrepreneurship came from the CSO. Data released this week showed significant increase in employment across the employees and the self-employed. While the number of employees in Q3 2013 was up 27,300 over the year, the number of self-employed persons increased by 30,100. Traditionally, self-employment is the first step en route to entrepreneurship. The numbers of self-employed with paid employees in Q3 2013 was below that recorded in Q3 2011. This and the sectoral decomposition of the jobs creation suggests that the new employment is not being linked to entrepreneurship.


All of this suggests that we have significant road to travel before Ireland becomes a powerhouse of entrepreneurship. The good news is – there are plenty of reforms that can help us on the way.

Last week, the US-based Kauffman Foundation, the largest research centre in the world for studies of entrepreneurship, published the results of its annual Global Entrepreneurship Week survey. The study reveals the snapshot of the state of play in entrepreneurship and start-ups formation across 113 nations and 2,330 current entrepreneurs. Amongst the handful of nations that did not participate was the entrepreneurial haven of Ireland.
Nonetheless, coupled with other sources of data, the Kauffman study offers us some good insights into the role of policy and regulatory environments in supporting entrepreneurship. Many of these insights overlap with what we observe in Ireland.

One of the keys to creating an environment supportive of entrepreneurship is to incentivise equity-based investment. Instead, we have an environment that favours debt. The problem with over-reliance on debt to finance corporate investment is that it has been shown worldwide to stymie the rate of growth in firms. It also lowers the speed of transition from family ownership to professional management.

Ireland lags behind core competitors in terms of banking sector culture when it comes to funding entrepreneurs. This is a function of two factors: low lending capacity in the system that is currently undergoing deleveraging of bad loans, and the long-term historical legacy of lending against physical collateral. We can do something about both, if we get creative. A gradual improvement in lending capacity by the banks can be achieved by reducing risk profile of SME loans. For example, a co-insurance scheme for viable new and existing loans using Enterprise Ireland funds can work to free some of the better quality business loans for securitisation. Co-insured loans can have an equity conversion component for added security. Such enhancements of better loans can help start the process where the banks lend against market and product potential of the specific SMEs instead of lending against physical collateral.

Another area that is commonly identified as a strong support for entrepreneurship is cost of and access to advisory services, starting with accounting and legal services and extending into technological advice and strategy. Ireland has achieved some improvements in the accounting costs area, but is lagging in terms of legal costs competitiveness. Critically, however, there are too few private advice networks available to would-be entrepreneurs. And there are too many state-run ones, often with limited expertise and excessively costly bureaucracy.

One recent OECD report clearly states that Irish system of innovation and entrepreneurship supports is Byzantine – spanning over 170 budget lines and 11 major agencies relating to scientific innovation alone.

We need a more active system of business development and incubation centres not only for start-ups in strategic sectors, such as ICT, bio, and food, but also in domestically-trading ones. Such centres can co-locate with major MNCs and / or be a part of broader business networks. However, the key point is resourcing them. Consolidating and re-configuring currently operating systems of local enterprise boards, FAS, and numerous other quangos crowding this space can help.

Tax systems need to be reformed to support not only creation of business, but transition into entrepreneurship. Currently, transition to entrepreneurship is only made more onerous by the absurd system of USC and PRSI taxation. To do better we need to increase VAT applicability threshold to EUR80,000-100,000 of earnings for self-employed, and dramatically reduce USC and PRSI on self-employed and sole traders.
The problem of tax disincentives for knowledge and skills-intensive start-ups is solely down to ridiculously high upper marginal tax rate on income. Per IVCA Budget 2014 submission: “The effect of [high marginal tax rates] is that Ireland is becoming a “development ghetto” with high growth start-ups doing development here but building other functions e.g. sales and marketing elsewhere.”

An income tax incentive in the form of applying only the lower marginal tax rate on earnings generated in the first three years of self-employment can rectify this problem. It will also align taxation treatment of corporate entities with that of the sole traders.


Beyond this, employees share ownership taxation needs to be revised. In fact, we can be even more aggressive here by setting a CGT exemption or a reduced rate for all companies that facilitate creation of new enterprises. This will send a strong message to foreign investors that cooperative entrepreneurship with indigenous start-ups is encouraged here. Given that many Ireland-based MNCs are actively developing partnerships involving start-ups around the world, an aggressive tax policy stance in this area can even act as an added incentive for MNCs to invest more in Ireland.
In short, there is plenty of room for improvement and innovation in terms of national policies on entrepreneurship. This should be treated as a major opportunity for Ireland, a chance expand and strengthen our indigenous enterprise formation. If entrepreneurship is really a state of mind, policy and support institutions to foster entrepreneurial culture are a matter of will. Having the former without the latter is simply not enough.

Box-out:

A recent report from the McKinsey Global Institute examined the distribution of economic costs and benefits arising from the set of unprecedented monetary policies in the advanced economies. The study found that from 2007 to 2012, quantitative easing measures deployed in the euro area, the UK, and the US yielded a net benefited of USD1.6 trillion to the Government sector. These benefits were generated through reduced debt-service costs and increased profits remitted from central banks. Even euro area peripheral states’ governments have gained from these measures by facing lower costs of funding their crisis responses and by channeling funds from the banks to the Exchequer via Central Banks. At the same time, larger non-financial corporations gained some USD710 billion due to lower interest rates on debt. The only sector of the economy that was an unambiguous loser in this game of monetary policy chairs were the households. Households in the US, the UK and the euro area lost USD630 billion in net interest income. The costs were mostly concentrated amongst older households that tend to hold more interest-bearing assets. The study excluded the adverse effects on households that arise from increased taxation, reduced public services and benefits, and from higher bank loans margins.

4/12/2013: Did US banks deregulations spur SMEs productivity?

An interesting study via Kauffman Foundation of the effects of banking sector deregulation and competition on SMEs productivity in the US.

Krishnan, Karthik and Nandy, Debarshi K. and Puri, Manju study, titled "Does Financing Spur Small Business Productivity? Evidence from a Natural Experiment" (published November 21, 2013 http://ssrn.com/abstract=2358819) assessed "how increased access to financing affects firm productivity" based on a large sample of manufacturing firms from the U.S. The study relied on "a natural experiment following the interstate bank branching deregulations that increased access to bank financing and relate these deregulations to firm level total factor productivity (TFP)."

Core results "indicate that firms' TFP increased subsequent to their states implementing interstate bank branching deregulations and these increases in productivity following the deregulation were long lived."

In addition, "TFP increases following the bank branching deregulations are significantly greater for financially constrained firms. In particular, …we show that firms that are close to but not eligible for financial support from the U.S. Small Business Administration (and are thus more financially constrained) have higher TFP increases after the deregulation than firms that just satisfy eligibility criteria (and are hence less financially constrained)."

Overall, the "results are consistent with the idea that increased access to financing can increase financially constrained firms' access to additional productive projects that they may otherwise not be able to take up. Our results emphasize that availability of financing is important for improving the productivity of existing entrepreneurial and small firms."

By proxy, the results also show that increased presence of banking institutions in the economy does contribute positively to productivity enhancing funding availability for the firms.

18/11/2012: Innovation, Professionalization of Risk, Stagnation?

The recurrent theme in forward thinking nowdays is the decline of technological 'revolutions' cycle. I wrote about this on foot of earlier research (here) and in recent weeks there has been another - most excellent - article on the same topic from Garry Kasparov and Peter Thiel (link here).

Two quotes:

"During the past 40 years the world has willingly retreated from a culture of risk and exploration towards one of safety and regulation. We have discarded a century of can-do ambition built on rapid advances in technology and replaced it with a cautiousness far too satisfied with incremental improvements."

The irony has it that in our collective / social pursuit of certainty, we have surrendered risk pricing and risk taking to the professional class of the 'bankers' who proceeded to show us all that they are simply incapable of actual investing. The delegation of risk authority to them, compounded with over-taxing risk taking via tax systems and strict bankruptcy regimes, has meant that real equity and real investment have been replaced with financial instrumentation of debt and financial instrumentation of creativity.

"Many investors practise a fake form of long-term thinking. Portfolio managers see the returns of the 20th century and project those far into the future. Tomorrow’s retirees are betting their fortunes on the success rates of yesterday’s companies. But the vast wealth registered by modern capital markets came from technological feats that cannot be repeated. If nobody takes the risk to invent products that produce new industries and new profits, then analysing historical returns from the 20th century will be no better guide to our future than researching crop yields from the 10th century. Without innovation, faith in the stock market is a kind of cargo cult."

We are no longer thinking - as a society - in terms of risk as an input into production of new goods, services, value-added in the economy, but see it as both as a negative utility good (something to avoid and reduce) and as a fertile ground for taxation (a logical corollary in the world where risk is a matter of 'professional' fees collection, and not an input into innovation). The social structures of modern democracies in the West are now wholly committed to reducing risk impact on households - the Nanny State - and thus taxing risk returns.

"Above all the future will be created by individuals. Those with the most liberty to take on risk and make long-term plans, young people, should consider their options carefully. ...The coming generation of leaders and creators will have to rekindle the spirit of risk. Real innovation is difficult and dangerous but living without it is impossible."

Note: beyond 'professionalization' of risk, there also remains the issue of 'financialization' of risk. While Kasparov and Thiel clearly focus on the latter aspect, my comments focus on the former. But the two are not, in fact, separate - the financialization is impossible without professionalization, and vice versa.

26/10/2012: Few interesting links

Some links on recent studies of interest

Two hugely important studies from the Kauffman Foundation on the role of immigration in entrepreneurship and human capital as a driver of future economic growth.

Iceland's assessment of financial stability for 2012 Q1 covering in detail household debt dynamics (from page 23) and detailing the success of the Iceland's systemic debt restructuring arrangements.

10/1/2012: Entrepreneurship and Chaos

In a slight departure from macroeconomic focus of the blog, here are two links to, in my view, pivotal articles on business and entrepreneurship. Pivotal not because they provide the answers, but because they raise questions I suspect will be the most important ones in years to come.

So enjoy:
http://www.inc.com/eric-schurenberg/the-best-definition-of-entepreneurship.html
and
http://www.fastcompany.com/magazine/162/generation-flux-future-of-business

And I would be interested in your views on these as well.