26/10/2013: Europe's Structural Deficits & Ireland's Headache...

As you know, I prefer not to blog extensively on economics matters over the weekend. However, due to work time constraints this week, I have accumulated lots of interesting material that requires some catch up blogging... so here are some new posts on economics matters...

First up: an interesting chart summarising neatly the problem of Irish fiscal consolidations to-date and the reasons why we are not out of the woods yet.

The above plots structural deficits in the EU (in other words the deficits that would have prevailed if the economy was not in a cyclical recession or downturn), as estimated by the EU Commission. Less questionable are those deficits derived using the IMF methodology:

According to IMF estimates, Ireland's structural deficits are the fourth largest in the EU and are second highest amongst the 'peripheral' states.

For comparative, consider also the primary deficits (removing the cost of interest on government debt):

Ireland is the worst performer in 2013 in the EU (this might improve to the second worst given reclassification of EUR700 million in licenses sales from 2012 into 2013). Notice that Greece is already running primary surplus, while Italy is close to doing so.

The above clearly shows that the Exchequer in Ireland is far from achieving sustainable deficits trajectory and that any claims that Ireland is close to completing fiscal adjustment required to restore its public finances to health should be subject to serious reservations.

10/12/20111: Euro summit twin tests: deficits and structural deficits

In the wake of the European summit, it's worth taking a look at historical and projected future performance of the member states of the Euro area based on the parameters for fiscal sustainability.

First, consider historical performance of the Euro area member states based on the 3% Government deficit criteria. Charts summarize:

And a plot of all instances when Euro member states have fallen outside the 3% deficit sustainability criteria:

Let's summarize the above evidence:

As can be seen from the above, by the 3% deficit criteria, between 2000 and forecasted 2016,  only two states will have been in full compliance with the fiscal rule: Luxembourg and Estonia. Only two more state, Austria and the Netherlands, will see probability of falling outside the sustainability criteria below 30%. Seven Euro area states will have probability of not satisfying this criteria in excess of 50%. It is also evident, based on the IMF forecasts, that Ireland, Spain, Cyprus, Slovenia Belgium, Greece and France will have an uphill battle satisfying this criteria between 2012 and 2016. Ireland is by far the worst performing state in terms of required future adjustments with cumulative reductions required of 27.7% of GDP, followed by Spain with 21.8%.

Now, let us consider the 0.5% of potential GDP bound for structural deficits:

To summarize the above:

As shown above, with exception of Finland, no member state of the Euro area has been in compliance with this rule since 2000 through (forecast) 2016. The numbers for expected future adjustments required under this rule for 2012-2016 are horrific. Spain is the worst off country under this criteria, followed by Ireland, Cyprus and Slovenia. Things are also gloomy as the future adjustments go for all other countries, save Germany and, irony has it, Italy (due to the country lack of any growth potential), Netherlands and Portugal (same case as Italy).

In short, there is no real evidence that the Euro area can deliver on the targets set without

1. Running a truly depressionary level of fiscal adjustments over the next decade; 
2. Raising dramatically levels of sustained growth over and above current potential capacity in a large number of countries, but especially in Italy, Portugal and Greece, and
3. Exercising the levels of discipline that the Euro member states have not exhibited in their recent history.

13/11/2011: Euro area - history of insolvency

Nouriel Roubini makes a very compelling argument as to the nature of the Euro area crisis - the nature revealed by unsustainable economic model based on running excessive external deficits and accumulating debt (see his blogpost here).

I have frequently referenced this problem to a deeper underlying force - the propensity of the European social democratic models to spend beyond their means. As the Euro area economies pursued populist agendas of 'social' services and subsidies expansion throughout the 1990s and 2000s, some (indeed majority) of the European economies stagnated, implying diminished capacity to sustain subsidies transfers within the vested interests-run Union. Thus, current account deficits - mask both Government and private sectors imbalances (with Governments in effect pumping the private economy with steroids of debt and cheap interest rates to extract tax rents that can be used to finance political largesse).

To see this, look no further than the links between Current Account deficits (external imbalances across entire economy - public and private) and Government deficits (fiscal imbalances), as well as Structural deficits (fiscal imbalances corrected for recessionary impacts).

Chart below shows cumulated current account deficits for 12 years since 2000 as well as cumulated structural deficits.

The striking feature of this chart is that over 12 years horizon, only 6 countries of the Euro area have managed to post a cumulative external surplus, while only one country (Finland) has managed to live within its means both in terms of external balance and fiscal balance. Any wonder that Finns are so opposed to the idea of 'burden sharing' that will see their surpluses transferred to the profligate states?

Another striking feature of the graph is that, contrary to Mr Roubini's assertion, France too was running dual external and fiscal deficits. Albeit, its deficit on current account side was small. Germany - another paragon of 'stability' run structural deficits on the fiscal side - i.e. spent beyond its means when it comes to Government expenditure outside that needed to correct for recessionary imbalances. Ditto for the Netherlands.

Ireland - our engine of 'exports-led growth' - is, alas, firmly NOT an engine of external balances. Cumulated current account deficit for the country is -19.5% of GDP. Any hopes for reversing 12 years of that experience, folks, will require re-wiring of our economy, preferences, political and institutional structures etc. Good luck getting there before the whole house of cards comes tumbling down.

In fact, deficits are sticky - hard to reverse. Past deficit experience, it turns out, shapes much of the future achievement, as illustrated in the chart below.

Once you are insolvent for a decade (1990s) you are likely to remain insolvent for the next decade too (2000s). And, hence, the headwinds against us (Ireland) reversing that and moving into strong surpluses on current account in years ahead are strong. Not that they can't be overcome. If we look at transition from 1990s external balance position to 2000s position, the following holds:

• Finland and the Netherlands stand out as the only 2 countries that managed to improve their surpluses on the current account side between 1990s and 2000s averages
• France, Belgium and Luxembourg are 3 countries that managed to retain surpluses, but weakened their performance between 1990s and 2000s
• Malta was the only country that managed to reduce its external deficits between 1990s and 2000s in terms of averages
• Portugal, Greece, estonia, Cyprus, Slovak Republic, Sapin, Ireland, Slovenia and Italy all saw average deficits of the 1990s deepening in the 2000s
• Only two economies - Austria and Germany have managed to reverse previous deficits (in the 1990s) to surpluses in the 2000s. 

That means that, historically, a chance of reversing average current account deficit in the previous decade to a surplus in the next decade is 2/17 or less than 12%. not an impossible feat, but an unlikely one.

And current account deficits do appear to relate closely to the General Government deficits and Structural fiscal deficits as the two charts below show (note of caution - the equations estimated below are imprecise, of course, due to small sample).

At last, a table to summarize:

Yep, insolvency - of the deepest (across all three measures) variety is the domain of 10 out of 17 member states when it comes to the last 12 years of Euro area history. Another 5 member states are insolvent by two out of three criteria. Lastly, only two member states - Finland and Luxembourg - were actually fully solvent since 2000.

That, folks, makes for a rather spectacular failure of the Euro area institutional design.