For those of you who missed my Sunday Times article, here it is in an unedited version (scroll below).Here is a link to my Friday's quote in WSJ editorial.Our Government keeps droning on about Ireland not having a toxic derivatives problem in the banks… Hmmm… unless you count the banks themselves as derivative instruments. Take a look at our
loan-to-deposit ratios (LDRs):
AIB: 153% at end-June 2008; 140% in March 2009;
BOI: 174% in September 2007, 157% March 2008, September 2008: at 160.3%,
ILP: 245% in November 2008, 277.4% in September 2008.
Anglo: 124.2% in September 2008
Nationwide: 154% in April 2009 down from 170% in 2007
Now, according to a UBS survey of bank balance sheets of September 2008, Ireland's average loan-to-deposit ratio was 163.1%.
US average: 51% LDR for pre-1960, rising to 85% between 1960 and 1980; breaching 100% in 1997, then 113% in 2007 at its peak, down to 97% May 2009.
Yes, we don’t need securitized packages of MBS tranches to get ourselves thoroughly poisoned…
On to my Sunday Times article:Over the last two weeks, just as Brian Cowen was exulting over the prospects for Ireland’s return to economic growth thanks to his visionary policies, Russian Government, also facing a major economic crisis, unveiled a new set of economic programmes aimed at getting the state back on track. The package included a tough realistic Budget for 2009-2010, some tax breaks, a commitment to fiscal conservativism, an ambitious set of policies directed at reducing public sector waste, corruption and improving management practices, measures aimed at stimulating private sector investment and demand, and significant new initiatives in R&D and business and technology innovation.
To-date, Irish government sole responses to the crisis have been to raise taxes on businesses, consumers and income earners, and to cut capital investment. All to preserve excessively high level of current public expenditure. Moscow’s response was to cut wasteful spending, lower some business and personal tax rates and rationalise new investment programmes to focus on future growth priorities.
Hence, an ordinary working person in Ireland is now facing an effective tax rate of over 22% - up from 19% a year ago. Her counterpart in Russia is facing a flat rate income tax of 13%, the same as in 2008. An average Irish self-employed person is looking at surrendering over 32% of her income in income tax, up from 29% a year ago. Russian self-employed workers enjoy a new 6% income tax, down from 13%. In terms of incentives, it is clear that Irish Government’s priority is to skin the small entrepreneurs, while the Russians are taking an approach of encouraging individual risk-taking in business.
While Ireland is facing a double-digit fiscal deficit, our current expenditure continues to rise unchecked since July 2008 Government promise to get it under control. The Government is yet to produce a single forecast that actually projects a decrease in current expenditure at any time between now and 2013. This unambiguously signals that Irish leadership envisions fiscal policies adjustments to be fully financed out of increasing tax burden on the ordinary households and businesses.
In contrast, Moscow is cutting spending outside priority areas and temporarily shifting funding from longer-term investment projects. In effect, the Russians retain ring-fenced commitments to invest significant funds in new technologies and SMEs – areas earmarked for future growth, but the Government is borrowing short-term some of the already allocated funds to finance more immediate crisis-related spending.
For example, a year ago, Russian state allocated some €2.3bn for investment in nanotechnologies to cover its programmes over the period of 2009-2015. Last week, the Government wrote Rusnano – semi-state investment company in charge of the funding – an IOU for almost €500mln of these funds, temporarily withdrawing cash without sacrificing any of its investment programmes.
This reveals a more sustainable funding model for state investment in Russia that is based on pre-funding and ring-fencing long-term investment, than the one we have in Ireland, where current revenue is used to finance public investment irrespective of the length of investment horizon.
Other measures enacted by the Russian government in combating this crisis, such as export credits supports, aid to SMEs and state financing of some enterprises (either via equity stake purchases or preferential loans) would fit well in our own policy arsenal, were we more prudent with our expenditures in the years of economic boom. In just 7 years between 2002 and 2008, Russian fiscal authorities built a war chest of funds to sustain necessary public spending and investment. Even after almost a year of financing growing primary imbalances, Russian reserves currently stand at approximately 21% of 2008 GDP. Ireland’s NPRF never exceeded 12% of Ireland’s 2008 GDP – hardly an impressive record of state ‘savings’ over 17 years of robust growth.
History aside, Russian experience shows that forward policy planning and fiscally conservative approach to current spending are the necessary ingredients in dealing with a crisis. Which brings us to the scope for long-range reforms that present a feasible alternative to the present Government plans.
First and foremost, long-term changes are required in our taxation. This much is admitted even by our policy cheerleaders in the Department of Finance and the ESRI. However, to date, there is no indication that the taxation commission is guided in its decisions by the future growth considerations, rather than by the immediate objective of raising new tax revenue.
If Ireland were to seriously pursue high value-added growth development model, our taxation policy has to be altered dramatically. The burden of financing the Exchequer spending, currently disproportionately falling on the shoulders of the above-average income earners (majority of whom represent the same knowledge economy we are trying to expand) must be shifted away from personal income to less mobile physical capital. This will incentivise investments in education, labour productivity-enhancing R&D, training and other forms of human capital, and reduce the wage-costs pressures on companies that operate in the knowledge-intensive sectors. One of the means for delivering such a change would be to levy a significant tax on land offset by reductions in the upper marginal income tax rate.
Another aspect of the tax reform that can stimulate creation of sustainable long-term economic activity in Ireland is an idea of dramatically reducing self-employment and proprietary income tax in line with the Russian experience. Self-employed individuals assume all the risk of running their own business without gaining any of the tax benefits that accrue to corporations. Lowering personal income tax on self-employment to a flat rate of, say, one half of the effective rate of tax applying to an employee earning €60,000 pa (currently standing at 32%) will go a long way in encouraging shift from unemployment into small entrepreneurship.
A different issue is now resting in the hands of yet another Government commission. Current public sector pay, financing systems, and managerial and work practices are simply out of line with the rest of our economy. Across all sectors of Ireland Inc, public sectors sport the lowest value added per unit of labour inputs. Ditto for comparing Irish public sectors productivity against other small open economies within the OECD. Yet, the cost of financing these services is accelerating even during the current downturn, just as the sector overall output is falling. This is hardly news: since the mid 1990s, the range of services and products supplied by the state has been narrowing, yet the staff levels, especially at the top of the pay scale, remuneration costs and non-pay benefits grew.
Reforms must address this exceptionally poor performance, as well as restore pay and benefits to reflect low levels of productivity and value-added delivered by the public sectors.
However, even more important for the long-term growth is to enact systematic principle of separating service provider from the payee. In effect, Irish public sectors are quasi-regulated near-monopolies in their respective industries. Modern services in a small economy cannot function efficiently if the State employees responsible for these services provision are also responsible for pricing and rationing access to the services, regulating services supply and restricting external competition. Irish public sectors price inflation shows conclusively the overall lack of efficiency in our public services provision (see chart).
The Government should elect to provide payment for public access to services, without any prejudice in the choice of service provider. Thus, for example, in health, once standards for quality and safety are adhered to, any approved and properly regulated provider should be allowed to supply medical services to patients. The Exchequer should ensure that those without sufficient income are given state funds to access necessary services. But the Government should exit the business of actually supplying medical services.
Such reforms promise delivering on several key objectives. Experience in other countries, where services provision and access were effectively separated in the 1990s shows that existent service providers do engage in cost-reducing competition, thereby drawing down the cost to the Exchequer. Second, the range and quality of services supplied are improved. Third, granted critical access to the market, new enterprises and thus new employment grow, with some supporting export of such traditionally domestic-only services abroad. Fourth, services consumers do welcome greater choice of service providers and better quality of services. Separation of service provider and payee is a basic concept of organizing modern public services that is yet to dawn on our allegedly highly enlightened politicians and civil servants.
After some 11 months since the current Government has first acknowledged the existence of the economic and financial crises, it is both surprising and disheartening to observe continued lack of policy responses from our leadership. Yet now is not the time to sit on our hands and wait for the US and global economy upturn to rescue Ireland Inc. Instead, it is time we start putting in place few policies that can underpin the recovery in the short run, but can provide support for future long-term growth as well. Tax reforms and public sector revamp certainly top the priorities list.
All scenarios are explained above and all assumptions are in there as well.
