11/1/19: A Behavioral Experiment: Irish License Plates and Household Demand for Cars

While a relatively well known and understood fact in Ireland, this is an interesting snapshot of data for our students in Behavioral Finance and Economics course at MIIS.


In 2013, Ireland introduced a new set of car license plates that created a de facto natural experiment in behavioural economics. Prior to 2013, Irish license plates contained, as the first two digits, the year of car production (see lower two images). Since 2013, prompted by the ‘fear of the number ’13’’, the license plates contain three first digits designating the year and the half-year of the make.

Prior to 2013 change in licenses, Irish car buyers were heavily concentrated in the first two months of each year - a ‘vanity effect’ of license plates that provided additional utility to the earlier months’ car purchasers from having a vehicle with current year identifier for a longer period of time. Post-2013 changes, therefore can be expected to yield two effects:
1) The ‘vanity effect’ should be split between the first two months of 1H of the year, and the first two months of 2H of the year; and
2) Overall, ‘vanity effect’ across two segments of the year should be higher than the same for th period pre-2013 change.

As chart above illustrates, both of these factors are confirmed in the data. Irish buyers are now (post-2013) more concentrated in the January, February, July and August months than prior to 2013. In 2009-2012, average share of annual sales that fell onto these four months stood at 44.8 percent. This rose to 55.75 percent for the period starting in 2014. This difference is statistically significant at 5% percent level.

The share of annual sales that fell onto January-February remained statistically unchanged, nominally rising from 31.77 percent for 2009-2012 average to 32.56 percent since 2014. This difference is not statistically significant at even 10%. However, share of sales falling into July-August period rose from 13.04 percent in 2009-2012 to 23.19 percent since the start of 2014 This increase is statistically significantly greater than zero at 1 percent level.

Similar, qualitatively and statistically, results can be gained from looking at 2002-2008 average. Moving out to pre-2002 average, the only difference is that increases in concentration of sales in January-February period become statistically significant.

In simple terms, what is interesting about the Irish data is the fact that license plate format - in particular identification of year of the car make - strongly induces a ‘vanity effect’ in purchaser behaviour, and that this effect is sensitive to the granularity of the signal contained in the license plate format. What would be interesting at this point is to look at seasonal variation of pricing data, including that for used vehicles, controlling for hedonic characteristics of cars being sold and accounting for variable promotions and discounts applied by brokers.

Irish Boardrooms in Denial

This is an unedited version of the article published in Business&Finance Magazine, February 26, 2009, pages 30-31

Almost a year ago, I warned in this column that Irish companies are going to face a tough recession, with rising bad debts, tighter payments collections and accelerating rate of insolvencies. A recession that is likely to last through 2009 and a good half of 2010. Figures for 2008 show us on track to fulfil these predictions with more than doubling of the number of corporate insolvencies in one year. By all possible indications, 2009 is going to be even tougher than the already abysmal 2008. And yet, when it comes to a realistic assessment of business conditions there is a strange sense of denial of reality taking hold in Irish boardrooms.

First consider recent evidence. Two weeks ago, CSO recorded the first drop in industrial output in Ireland since 1982. A combination of collapsed construction sector activity, decimated domestic consumer spending and ever-shrinking global demand, exacerbated by the overvalued Euro all have contributed to this trend. Even more significantly, these forces’ impact on Irish producers, exporters and service providers is getting stronger by the day.

Exporters under pressure
2008 slowdown in output was primarily due to traditional sectors of the economy – down 4.7% in y-o-y terms, with multinational companies expanding their production by an anaemic 1.7%. There is little hope that this latter trend will not continue through 2009 and into a good part of 2010. More ominously, December figures show broadly based collapse in industrial activity with output contracting by more than 10% m-o-m in both multinational sector and amongst domestic companies. 26 out of 29 broader industry categories recorded contractions in output. Figure below highlights this, while removing some of the seasonal volatility.
Source: CSO

This is broadly in line with international experience. Last week figures showed that in 2008 Europe posted its biggest trade deficit in 10 years – a whooping €32.1bn. This marked a deterioration in the trade balance to the tune of €48bn in y-o-y terms. According to the majority of the analysts, coming months will see severe recessionary pressures for eurozone exporters. Irish exports are particularly vulnerable, given the falling consumer demand and business investment activity in the US and UK, as well as in the emerging countries. Exports to the UK, the main destination for the region’s products, dropped 3 percent in the 11 months through November 2008. Exports to the US, the second-biggest buyer of euro area goods, fell 5 percent. In the case of Ireland, the two countries account for more than 36% of the goods exports flow by value and some 50% of all Irish trade is linked to either the Dollar or Pound Sterling.

The end result – our core industrial exports are facing a decline, as illustrated in the figure below, precisely at the time of already collapsed domestic consumption. Our services exports are also facing decline with financial services and tourism struggling to stay afloat, while broader business services exports are feeling the same pressures of currency overvaluation and high cost of credit as our goods trade.Source: CSO

The expectations are that the 2008 growth sectors – ICT and pharma – might be also hard hit by a slowdown in global demand this year. In particular, ICT is sensitive to households and business investment demand. Lack of new investment in plant and equipment, software and operating systems in the US and across Europe is taking its toll on the likes of Dell, Intel and smaller hardware and software suppliers. By all estimates, this sector is not going to see a significant recovery until the earliest second half of 2009. Dell alone accounts for some 6.5% of Irish exports.

At the same time, pharma sector is likely to face mounting cost pressures in the US, a significant decline in demand for higher-end drugs from the emerging economies, plus a stronger generics competition. A recent study by the International Pharmaceutical Policy Council has shown that traditional pharma and bio-pharma sectors are facing significant cuts in research spending and employment, with recession undercutting public and private spending on universities-affiliated research. In the mean time, last week, Israel-based Teva Pharmaceutical Industries Ltd., the world's largest maker of generic drugs, said it expects the deepening global recession to spur demand for generics – bad news for the likes of Big Pharma that dominate Ireland’s exports statistics. In other words, even the so-called ‘recession-proof’ pharma companies are starting to feel the heat.

Yet to face the music
Which brings us back to the corporate boardrooms perceptions of the near term future. Last week’s InterTradeIreland Quarterly Business Monitor sheds some light here.

A comprehensive survey of some 1,000 companies north and south of the border has revealed that businesses are more pragmatic in their assessment of the past than they are about the future. In other words, Irish companies are feeling the pain, but are potentially deluding themselves into believing that the first half of 2009 will turn out to be economically stronger than the consensus forecast predicts.

In terms of the current conditions, roughly four out of five businesses indicated that they have experienced an adverse impact on trading conditions in recent months. This is hardly surprising, given that the biggest problems reported by business leaders were impacting their core parameters: tighter cash flow (68%) and decline in demand (66%). Some 87% of businesses noted a fall-off in consumer spending. 61% of the Republic of Ireland businesses saw a fall in turnover as opposed to 44% in the North.

Nonetheless, when asked which policies the Government can undertake to help business,
• 27% cited the need for improving access to borrowing (most likely indicative of the severe pressures on debt-laden businesses to raise new credit and roll over maturing short-term debt),
• 9% called for reduced levels of VAT and 7% for reduced taxation,
• 7% named assistance for SMEs, and 6% identified financial assistance for distressed companies.
The low numbers supporting consumer confidence improving tax reductions measures suggests that majority of businesses are not perceiving the current downturn to be demand-driven. Instead, there seem to be a much stronger conviction that the recession is a function of the credit cycle. Yet, 61% of business in the South (as opposed to 44% of those in the North) reported declining turnover.

Do the companies underestimate the extent of the collapse in consumer confidence at home, demand for exports abroad and the extent of their exposure to debt markets? Judging by the main policy priorities listed above, the answer is yes. The same answer is supported by the fact that few companies so far have taken significant cost-cutting measures. Only 30% of the Republic of Ireland companies (19% in the North) have reduced their workforce to the end of 2008. This is reflective of the fact that just 18% of businesses expected the downturn to have a severe adverse impact on their business in the next 12 months. Majority (63%) still think that this recession will be a moderate and short-lasting one.

And this is despite the fact that forecasters virtually unanimously predict 2009 to be worse than 2008 when it comes to trading conditions. For example, McKinsey Global Economic Conditions Survey last month has shown that 71% of global businesses expected general conditions to worsen in Q1 2009.

Chart below shows that Irish business leaders pessimism about the future has increased only marginally between the end of 2007 and the end of last year, despite the rapid deterioration in Irish economic conditions.

Potential Impact of Economic Downturn, 12 months forward
Source: InterTradeIreland, 2009

Optimism amongst businesses, although having abated in 2008, remains relatively high. Only 39% of all Irish businesses anticipate a decrease in turnover in Q1 2009 as opposed to 52% of global businesses in McKinsey survey. Similarly, for profitability – only 35% of Irish businesses expect a decline in profitability in Q1 2009, against 67% for the global sample.

Thus, only 14% of businesses across the island (18% in the Republic of Ireland) expected more layoffs and redundancies in Q1 2009. This is well below 29% of the global sample firms that were planning layoffs for this quarter.

In short, consistent with the findings on employment, turnover and profitability, the Intertrade Ireland results suggest that Irish businesses, both sides of the border, expect a mild recession to last no longer than 6-8 months. At the same time, global business leaders expect “a battered but resilient economy …[that] implies a recession of 18 months or so”, much in tune with the forecasts by the EU, IMF and the OECD. One side of the sea is clearly foolin itself here…

Box-out: IFSC Liabilities

A research note from the Davy Stockbrokers last week attempted to clarify the issue of the banking sector liabilities in Ireland. According to the Bank for International Settlements data, in Q3 2008 banking liabilities of the Irish-owned banks totaled €575bn, or 309% of GDP – the third-highest in the euro area. The Irish government has guaranteed €440bn (or 237% of GDP) of this. At the same time, the liabilities of all financial institutions resident in Ireland were €1,424bn, or 839% of GDP. But €849bn of that “…is not in any way a liability of the Irish government,” says the Davy note.

Well, sort of. €849bn might not be a liability under the Government guarantee scheme (although it remains to be seen how the foreign banks deposits and loans by and to Irish residents will be treated in the case of default) but from the economy’s point of view – some share of the €849bn debt represents a potential risk exposure for the state.

Here is how. Recall the good old days when our country leaders trotted the globe telling everyone that IFSC is a flagship of our knowledge-based modern economy? How come we now conveniently shrug off any liability inherent in having IFSC on our soil? IFSC is an asset to Ireland: a major contributor to the exchequer, a large employer of Irish workers and a significant purchaser of associated business services, including the services of the stockbrokers.

Now, imagine if excess debt exposure of IFSC-based companies was to drive them out of business. Where would that leave the State, not to mention the economy? A rough guess – ca €700mln in Exchequer revenue, plus the returns from employment of ca 20,000 people, plus commercial rents returns and VAT returns due to business activity. The total state take from the IFSC can easily exceed €1.5bn. If the risk of losing this dough is not a liability for the Irish state, what is?

Davy is correct in the strict sense of listing the actual figures. However, ignoring the IFSC-held liabilities creates an illusion that somehow Ireland Inc is independent of what is happening in the Docklands and beyond. It is not. Just as in good times we reaped the benefits of the IFSc, we must, at the time of challenges acknowledge its liabilities as being at least in part our own.

Some housekeeping: a handful of updates

A cleaning up of some of my emails provided for a digest of interesting updates on the topics already covered in other posts. Here is an attempt to combine these...

To the QNHS (here) and Live Register data (here):

Per Davy note: "The worst affected areas [of unemployment] are building and those service sectors related to construction and the global financial crisis. Construction employment slid 7.6% quarter-on-quarter, followed by hotels and restaurants (- 3.2%), retail/wholesale (-2.3%) and financial/business services (-1.9%). No pain-sharing is evident in the data: private sector employment dropped 97,400 over the last 12 months while public employment increased by 10,000."

Last night I was a guest on a Late Debate (RTE Radio 1) alongside a SIPTU rep who was clearly traveling in some parallel reality claiming that:

• public sector took all the pain of adjustment to-date;
• those on higher incomes took no pain to date; and
• layoffs in public sector would be equivalent to layoffs in private sector.

Per point 1 - Davy note says it all, but an update on Exchequer results below also highlights the same.
Per point 2 - October Budget 2009 and its update, November Finance Bill II, both imposed progressively increasing Income Tax Levy on higher earners.
Per point 3 - two facts: (1) wage to value added ratio in Public Sectors (average) is ca 30% lower than in the Private Sector and some 1/3 lower than in the Financial and Business Services, and (2) wage to value added ratio in majority of public sector categories is close to or less than 1, so cutting 1 person out of the public sector would cost economy nothing (for ratio of 1) or would save economy some resources (for ratio is <1).
One caveat - of course, within Public Sector there are people who are highly contributive to the economy. For example: both IDA & Enterprise Ireland are aggregated into the above averages. These agencies have been significant contributors to the economic welfare in this country. Similarly, within each category, there is little understanding as to the variance of wage/ productivity ratios. E.g, do higher salaries in our flagship Universities relative to the second-tier third level institutions correspond to the productivity differentials? Knowing internal operations of Trinity, not exactly, but fairly closely. Thus, raising taxes in a 'proportionate' way as the Unions insist will hurt disproportionately more those who earn higher wages because of their higher productivity, even in the public sector.
Per Unions' 'Alternative Universe' - I got a general sense that our Unionists simply do not understand that in all instances, public sector workers depend for their wages on private sector earnings. Somehow, the Bearded Men of SIPTU/ICTU/CPSU/TGWU and the rest of the alphabet soup do not get the concept of who pays for what in this economy.

Per Exchequer Returns, February 2009 (here): there is significant evidence of deep wage cuts in private sector as income tax revenue continued to slide in January and February, despite the introduction of the income tax levy. In addition, current (non-capital) spending was up 3% y-o-y in February 2009. 2009 current spending is now on track to reach over 38% of Irish GNP - matching the record high achieved in 1983. Pure waste!

Financials and Other Stocks: as Davy puts it in a recent note: at the end of February 2009, the entire Irish Financial Sector accounted for only 3.5% of the Irish Stock Exchange capitalization as compared to 37.5% a year ago. This is diversification through attrition. The ISEQ dropped 10.3% in February - its sixth successive monthly decline. This was "the worst February performance in its 25-year history. It underperformed the FTSE Eurofirst 300 index, which also experienced its worst February performance, by 0.6%." A picture is worth a 1,000 words (all courtesy of Davy):
The last chart of course shows that Ireland is a absolute under-performer in its peer group. Davy do not analyse earnings in this context, but the above valuations are hardly making the shares cheaper. Earnings declines are now precipitous for all companies and my suspicion is that P/E ratios are falling. In other words, there is a question to be asked if there are any bargains out there given the earnings projections?Lastly, Davy provide a good snapshot of the bond markets dynamics in the chart reproduced above. Spot the odd-one-out? Note the timing of our departure to the Club Med of Near-Insolvent States - bang on coincident with Mr Lenihan's Budget... This should be a warning to everyone who is desperate for this Government to do something about the crisis: doing 'something', as opposed to doing the right thing, will make matters worse. Clearly, the markets are not seeing higher taxes and a lack of spending cuts (Budget 2009) as 'doing the right thing'.

Mansergh Calls for 'Celtic Tiger' Fat Cubs to pay their share in the downturn: Mr Mansergh - Bertie's pet in the Dail and a Junior Minister in the Cabinet - called yesterday for the tax measures in the mini-budget to focus on making sure that those who benefited most during the Celtic Tiger era pay more in taxes. Great idea from the Grand Weasel of Irish Politics. How about we start with Mr Mansergh himself - a person whose ministerial salary is out of touch with reality, and whose pension benefits are so lavish, that some bankers would envy the returns on so few years of such a non-demanding work as that of a Junior Minister for State with responsibility for the Arts. Mansergh serves in the cabinet which, with exception of 3-5 Ministers, is remarkable for its inability to do its job at a basic level. Yet the cabinet is being paid more than its counterparts in the US, UK, EU15 or indeed anywhere else in the developed/ democratic world. So, be my guest, Mr Mansergh - pony up, say 50% of your own income - you and your colleagues and their senior public service underlings are the Fat Celtic Tiger Cubs.

How bad will it get? IMF study

Here is a new insight into recessions dynamics. This time from the IMF (see link here).

What Happens During Recessions, Crunches and Busts? by Stijn Claessens, M. Ayhan Kose, and Marco E. Terrones (IMF WP/08/274) looks at "the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the period 1960–2007."

Data set covers 122 recessions, 112 (28) credit contractions (crunches), 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts).

The authors "find evidence that recessions associated with credit crunches and house price busts tend to be deeper and longer than other recessions... Episodes of credit crunches, house price and equity price busts last much longer than recessions do [4 quarters on average]. For example, a credit crunch episode typically lasts two-and-a-half years and is associated with nearly a 20% decline in credit. A housing bust tends to persist even longer—four-and-a-half years with a 30% fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities drops by half."

Of course we are experiencing far deeper contractions in house prices and equity valuations than an average bust.

"Most importantly, recessions associated with credit crunches and house price busts are deeper and last longer than other recessions do. In particular, although recessions accompanied with severe credit crunches or house price busts last only three months longer, they typically result in output losses two to three times greater than recessions without such financial stresses. There is also evidence that the extent of declines in house prices appears to influence the depth of recessions, even after accounting for the changes in other financial variables, including credit and equity prices, and various other controls."

Where is Ireland in all of this? We have:

• housing bust;
• credit bust;
• equity market bust;
• severe recession.

16-23% contraction in real output in Sweden and Finland in the recent past is a guide, according to the IMF study, for the type of recession we are in. Overall, there were only 4 episodes of coincident credit, equity and house prices busts.

Using econometric estimates (Tables 13.A and 13.B in the paper), we can parametrize the IMF model to estimate the expected contraction in Irish economy during the current crisis. Table below lists the underlying assumptions (in % changes) and results.Thus, under benign Scenario 1 assumptions, overall income contraction in Ireland over the recessionary cycle is expected to reach 13.5%, while under more severe Scenario 2 the contraction can result in a fall in real income of 16.1%. My personal view - we are going to see the latter rather than the former.

IMF study allows us to estimate the share of overall contraction that is attributable to the housing shock absent credit bust - in other words, due to purely domestic factors. This ranges from 66.6% in Scenario 1 to 63.5% in Scenario 2 - in both cases, a lion's share of the recession-induced economic pain is due to 'domestic' causes. At the same time, the share of recessionary decline in income that is attributable to 'external' or global factors (all shocks net of housing price bust) is ranging between 12.7% and 20.7%.

So much for the argument that we are in trouble because the rest of the world.

Trade and Unemployment Stats

Trade meltdown
Our latest trade situation is dire (here).

Although “Seasonally adjusted imports fell by 11% in December relative to November
2008 and exports fell by 4%,” in monthly terms things were much worse: “Relative to October 2008, imports fell by 1% in November 2008 while exports fell by 4%.”

So the overall dynamic is that exports are now collapsing at a faster rate than the deterioration in imports.

The reason is simple – imports started to suffer on the back of a much deeper contraction in the economy and this process was exacerbated by the Government-induced pillaging of personal disposable incomes since July 2008 announcement concerning the upcoming Budget 2009 - the first time Messrs Cowen and Lenihan have dipped deeper into our pockets. Exports lagged this process because our main buyers were more resilient to the global economic downturn than we are, because their Governments largely were not so insane as to raise taxes amidst a recession, and because Ireland-based multinationals engaged in a massive exercise to rationalize their taxes – booking more transfer pricing (thus supporting both imports and exports) via Ireland Inc. The chart - taken from CSO's release - shows exactly this timing and trade balance dynamics...Evidence? “The January-November figures for 2008 when compared with those of 2007 show that: Exports decreased from €83,062m to €79,873m (-4%)” with
• Computer equipment exports decreased by 27% (exactly offsetting a 26% decrease in imports in this category, implying very aggressive transfer pricing by the likes of Dell and others),
• Organic chemicals by 10%,
• Vegetables and fruit by 42%,
• Industrial Machinery by 15% and Metalliferous ores by 21%.
• Chemical materials increased by 35%,
• Medical and pharmaceutical products by 12% (imports in this category were up 18%),
• Professional, scientific and controlling apparatus by 30% and
• Petroleum products by 41%.

There is little evidence in the aggregate numbers that Irish exporting companies are suffering from the Sterling devaluation: shipments of goods to Great Britain fell by 5%, while shipments to Switzerland decreased by 22%, the Netherlands by 16%, Germany by 10%, and the Philippines by 49%. Dollar devaluation is not biting either with shipments to the US up by 2%, although most of this is probably due to transfer pricing.

Despite stronger Euro, imports of goods from Great Britain decreased by 7%, China by 18%, the United States by 6%, Japan by 28%, South Korea by 39% and within the Eurozone – from France by 13%, and Germany by 15%. Goods imports from Denmark increased by 50%, the Netherlands by 6%, Poland by 65%, Russia by 73% and Finland by 33%.

Yieeeks!

Unemployment - the bust is getting bustier...
Per QNHS data, also released today (here):

Q4 2008 there were 86,900 or 4.1% fewer people working in Ireland – “the largest annual decrease in employment since the labour force survey was first undertaken in 1975. This compares with an annual decrease in employment of 1.2% in the previous quarter and growth of 3.2% in the year to the fourth quarter of 2007.” Desperate stuff…

The overall employment rate among persons aged 15-64 fell to 65.8% from 69.0% in Q4 2007 with current employment rate running at the level of H1 2004, effectively implying that the last 4.5 years worth of growth have gone up in smoke within a span of less than 1 year.

There were 170,600 persons unemployed in Q4 2008 - an increase of 69,600 (+68.9%) in the year. The total number of persons in the labour force in the fourth quarter of 2008 was 2,222,700 – a decrease of 17,200 or 0.8% over the year. “This is the first annual decline in the size of the labour force since 1989,” says CSO. It is safe to assume that these figures do not include an outflow of foreign and domestic workers from Ireland. Overall, jobs destruction is thus much deeper than the QNHS figures imply.

All age groups showed an increase in unemployment with those aged 25-44 showing the largest increase (+33,500). The latter effect is, of course, due to the idiotic labour laws that imply that for any company it is virtually impossible to lay off older workers. This, in turn, leads to a situation where the productivity of individual workers becomes irrelevant to the decision to lay them off or to keep them on a payroll. The long-term unemployment rate was 1.8% compared to a rate of 1.2% in Q4 2007. The standardized unemployment rate was 7.7% in Q4 2008, up from 6.4% in Q3.

Conclusion:
In a normal democracy, the Government would probably fall on figures like these, but whichever way you spin the figures – Mary Coughlan being the Minister in charge of both Trade and Employment should find some final remnants of grace and tender her resignation.


As a side note, consider figure below:
Per CSO: “There were an estimated 476,100 non-Irish nationals aged 15 years and over in the State in the fourth quarter of 2008. Of these 349,300 were in the labour force, a decrease of 5,400 in the year to Q4 2008. An increase of 49,700 had been recorded in the year to Q4 2007. According to ILO criteria, 316,000 non-Irish nationals were in employment, a decrease of 18,700 over the year. A further 33,300 were unemployed, an increase of 13,300 in the year to Q4 2008. Nationals of the EU accession states showed a decline in employment of 16,800 and an increase in unemployment of 7,500 over the year. The unemployment rate for non-Irish nationals was 9.5% compared with an unemployment rate of 7.3% for Irish nationals.

In the fourth quarter of 2008 non-Irish nationals accounted for over 15% of all persons aged 15 and over in employment. Over 34% of workers in Hotels and restaurants, 18.8% in Other production industries and 16.7% in Wholesale and retail trade sectors were non-Irish nationals. The largest decreases in employment for non-Irish nationals occurred in the Construction (-10,100), Hotels and restaurants (-7,400) and Wholesale and retail trade (-5,100) sectors.” Now, detailed tables in the release show that in fact virtually no foreigners were employed in the public sector (ex health and education) per chart below.

Foreign nationals employment, 1,000s.So the total decline in foreing workers in mployment numbers of 86,900 was fully accounted, per CSO Table A1 as becoming either Unemployed (69,600), or out of the Labour Force (17,200), while 48,500 were Economically Inactive. Any idea how many actually left our shores?

S&P's visit: Pints!

S&P gang is in town (hat tip to P.O.) making rounds, sniffing out the need to slam the book on Irish bonds AAA rating. Better late than never, I'd say.

This blog has argued on numerous occasions (here and here) that Irish credit ratings should fall from their current AAA rating to at least AA-/A- levels. In fact, I called for S&P to climb down from its ivory tower of 'Ireland's low public debt...' myth and produce a more realistic assessment of the risks inherent in our borrowings (here).

This, of course, was predicated on:

• Irish Government's exposure to toxic banks debt (here);
• Irish Government's exposure to its own reckless spending (here);
• Irish Government's inability to carry out necessary economic policy adjustments to address the real crises in this economy: corporate and household debt (here), and public sector excessive cost to the rest of the economy (here and here);
• Irish Government's lack of realistic understanding of how economy works (here and here);
• Irish Government's wobbling on various aspects of economic policy (see all the Mushroom Cloud posts in January 2008 archive)...

...and so on. I can go on listing more reasons as to why this is no longer an economy warranting a gold-standard AAA rating, but let me put three facts in front of you:

Fact 1: Despite having (belatedly) recognized the need for some sort of crisis management solutions in July 2008, the Government has yet to produce any realistic plan for dealing with the above problems.

Fact 2: Courtesy of FT (hat tip to B.) there is a self-explanatory chart below (corrected per Anonymous update, the number for Irish bank liabilities should be at 396% of GDP). Of course, those of you who are regular readers would recognize this as something I have written about ages ago (here), but FT's authority helps.
Fact 3: Finally, another chart illustrates the fact that no one in the market actually believes that our bonds offer AAA protection from default.
Pretty conclusive, then? So what's the point of sending a team over to Dubs, S&P? To have a few pints with our BB&M Trio and listen to their assurances that our 'greenish knowledge innovation' errr... economy-thingy is steaming ahead?

To the icebergs, then, Captain Brian!

PS: I am currently working on preparing a comprehensive compendium of comparisons per our debts (across various sectors and maturities) to the rest of the Eurozone, so keep watching the blog...

DofF Forecast: Update I

According to today's reports, the y-o-y tax take in January is down 15% (hat tip to B.).

My personal projection, given the dynamics of 2008 tax intake (remember, Q1 2008 was still positive growth territory and lagged tax revenue was rolling in) is that we are going to finish 2009 with ca 15-17% down on 2008. 2007-2008 decline was 9.4%, implying we are going to collect €34,550-35,380mln in 2009 or a shortfall of up to €7,080mln on 2008 revenue, not €3,898mln as DofF forecast in January. My previous post forecast €7,698mnl shortfall, so January figure appears to be generally supportive of this.

As B. mentioned, this will bring our revenue to 2005 level - 'four years lost' as he puts it. This is about right - fundamentals (productivity, wages, costs inflation) all point to ireland having abandoned growth path around 2003-2004 which means a return - in nominal terms (using Eurozone average inflation rate) - to 2002-2003 levels by the end of 2011 will be mean reverting (with downward overshoot, of course) for underlying growth fundamentals.

P.S. Meanwhile - our Vacuum-Head in Politics Watch has spotted the following idea from Gay Mitchell (FG MEP). Surely, the nation falling off the cliff into an abyss of a severe recession and fiscal insolvency has nothing better to do than engage its MEPs in advocating Gaelic subtitles in cinemas. Too bad Gay's brain power never stretched to imagine watching a French or a German film with Irish and English subtitles littering the same screen. Oh, dear...

DofF Forecast: does it hold any water?

I have a serious question to ask of our Government: Do budgetary projections by the DofF in (e.g those contained in their January 2009 Addendum covered here) hold any water?

In particular, no one has yet taken the DofF forecasters to a task of explaining how on earth, with projected:

• shrinking GDP (-€7.6bn in 2009 in nominal terms relative to 2008) and GNP,
• negative inflation (-1%),
  
• rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%), and
• rising, not falling, Net Current Expenditure (+4.3bn in 2009),
  

does DofF come up with a revenue fall-off of just €3.9bn for 2009 relative to 2008 and total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009? (Those of you who are impatient enough, see one potential answer at the end of this post)...

These numbers - the backbone of Irish Government plans for the year - are suspiciously incongruous. Not only because they do not seem to add up. But also because we have no reason to trust DofF forecasts on the basis of their historical accuracy.

Do Government numbers hold up to scrutiny?
This week, it came to media attention that the entire Department of Finance employs only one PhD-level economist. As far as I am aware, we do not know:

1. Where and when did this person obtain her/his degree?
2. Was her/his degree in the field of macroeconomic modeling?
3. Has he/she ever published peer-reviewed research in the areas of taxation and/or macroeconomic forecasting?

In other words, we have no idea how qualified this economist is to carry out macroeconomic forecasting, policy evaluations and risk analysis.

Furthermore, per my knowledge, no one knows who exactly is responsible for supervision and execution of forecasting in DofF and what model is being used. Searching DofF website for Chief Economist reveals no such person. We do not know whether forecasting function is, indeed, an established and managerially resourced function of the Department. Ditto on the Risk Analysis side, which requires both an expert in microeconomic risk modeling and macroeconomic risk specialist.

It is simply not sufficient to say that accountancy or previous budgetary experience, potentially possessed by some DofF employees (how many?) qualifies the Department to deliver any sort of economic analysis or projections. Certainly not the ones which can used by the Government to argue about the need for one reform or another.

In fact, to see the absolute poverty of economic policy research output produced by DofF one should go straight to the source: here. They might as well publish these reports in Gaelic only, for no serious economist would recognize this as proper economics.

One example: in the sole document relating to economic reviews and outlook for 2008, titled Irealnd's Contribution to the Public Consultation Process on the Review of the EU Budget (I am not kidding - they couldn't even spell Ireland correctly). Here, DofF's 'Research' team devotes only 4 pages to the entire analysis of a vital fiscal policy process. The issue of EU-wide tax - something that was a hot topic of debate in Ireland throughout 2007-2008 is given 148 words! Of course, DofF gives five times this much to the discussion of CAP - suggesting, perhaps, our Finance boffins are more comfortable in the cow sheds than in the world of macro-finance and macroeconomics.

Getting basic research wrong - something that is being done by virtually all Irish Government departments on a routine basis - is a serious issue. Brandishing as a major reform a promise to get policies onto an 'evidence-driven' platform, as our Government did last week (see here: 3rd bullet point under Taxation heading), while having no capability to prepare proper economic analysis is hardly a responsible way of governing.

When even the mighty fail by poor research
Few months back, I was sent a research note from PIMCO's cult giant, Bill Gross. Gross is an archetypal salesman, in my view, who has fantastic intuitive understanding of the market (which is way more than our public sector mandarins and politicians have). This is, in most instances, sufficient to earn high rates of return and to contain downside risks.

But, it is not enough to do two things -
(a) provide rigorous analysis of your position in the market at any point in time - past, present, or future; and
(b) explain to others why your intuitive searchlight is capable of picking the right opportunities out of the mass of potential investment strategies.

Published in June 2008 (see here: those of you who attended my class last Fall in TCD's MSc in Finance would recognize it) the note contained a rant about US inflation indices. Specifically, Gross expended some 4 pages of small print arguing that

1. US inflation has been historically higher than measured by the CPI;
2. True US inflation should be much closer to the 'global' average (including such economically stable and developed countries like Venezuela, Indonesia, Brazil, Philippines, Thailand, Columbia, Turkey, Ecuador and Vietnam - out of a sample of 24 countries chosen, seemingly, to deliver Gross' point).
   

All of this led to the following conclusion:
"What are the investment ramifications [of the 'fact' that U.S. inflation is closer to worldwide levels than previously thought]? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars."

Lacking:

• serious analysis - Gross tweaked the evidence to support his own premise;
• proper investigation of academic and practitioner research - Gross ignored the fact that several Congressional and academic investigations since the early 1990s have concluded that CPI actually overestimates the true extent of inflation in the US by between 0.5% and 1% pa,

he produced a call to arms for investors that cost PIMCO and those who follow its strategy an arm and a leg. How? Gross' advice - issued in June 2008 -

• has missed a significant H2 2008 rally in Treasuries, Munis and TIPS;
• calling for heavier weighting for commodities-linked economies came at the time of extreme valuations of these economies (e.g Russia and Brazil both have peaked in June-August 2008), before they fell off the cliff in H2 2008;
• led to an unprecedented cancellation of dividends by several PIMCO munis funds - the first time in known history any fund suspended payouts for what is, in effect, a monthly yield-generating securities class.

I do enjoy the fact that, being criticised at the time for arguing against Gross' June note, I did turn out to be right about both his call on inflation (he was concerned with hyper-inflation as the world was teetering on the verge of deflation) and on emerging markets.

Back to DofF numbers
But I am not telling this story with some malice towards Gross or PIMCO in mind. At the very least, the man can spell Ireland better than our DofF boffins can. Instead, I am using it as an illustration as to the importance of proper research in backing any strategy - investment and/or policy-related. PIMCO's operations are much more superior to what is going on in our DofF and the rest of civil service when it comes to the quality of research and analysis. This implies that if people like Gross can get things spectacularly wrong, people that occupy our DofF - quipped with one token PhD level economist - simply have no chance at getting anything right.

Remember their latest numbers:

• shrinking GDP (-€7.6bn relative to 2008),
• negative inflation (-1%),
  
• rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%),
• a revenue fall-off for the Exchequer of just €3.9bn for 2009 relative to 2008, and
  
• a total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009

Well, of course to get these things to add up, one has to assume that tax increases passed in the Budget 2009 will not reduce tax revenue. In other words, that the Laffer Curve does not work. We shall see, of course, but empirical studies provide little comfort that such an assumption is a reasonable one. Ditto the numbers on retail spending in the NI and South of the border, SuperQuinn's plan to shut down supermarket located near Newry and loads of anecdotal evidence showing that Irish shoppers are fleeing the Republic for that VAT heaven of NI.

This spells serious trouble for the Government. Suppose that due to increases in the income tax, VAT and other taxes, the revenue were to decline by, say, 2.1% of GDP - as it did in less recessionary 2008. This would imply that tax increases will still be contributing positive revenue growth for the Exchequer, although on a much smaller scale. In such a scenario,

• the net Exchequer borrowing will jump from 6.3% of GDP to 8.4% of GDP,
• the General Government Deficit will rise by €3.8bn in 2009 - from 9.1% of GDP projected by DofF assuming €2bn in savings goes through, to over 12%.

Now, suppose tax increases wipe out any revenue gains by 2010 - the deficit will then rise to above 13% of GDP in 2009 and 15% in 2010.

Add to this the fact that while DofF was basing its numbers on -4% growth rate in GDP for 2009, the economy quite probably will contract by at least 5% - balooning potential deficit to 15-16% this year.

A scary thought, indeed, because even the IMF will not lend Mr Cowen a penny with such financial performance on the plans. So much for Brian, Brian&Mary's 'evidence-based' policies...

Corporate wipe-out and homeowners

Figures released by ICC Information today show that 21% of trading companies in Ireland have a ‘Negative Net Worth’. In other words, their balance sheet liabilities exceed the value of their assets. Net worth is composed primarily of all the money that has been invested since company inception, as well as retained earnings for the duration of its operation.

“A total of 28,513 trading companies in Ireland have a negative net worth according to their latest filed accounts. Not surprisingly the largest number of these were in the ‘Construction’ sector with 17.2%. However, in terms of actual monetary value ‘Leasing and Renting’ were top with a total negative net worth of over €7 billion.”

This is a scary sign of corporate debt overload, but it is also a sign of the unsustainable nature of many business models, especially those that emerged in 2003-2007 period of construction boom, based on cheap credit, over-supply of liquidity and overly optimistic valuations of demand.

This goes to the heart of debate about credit supply to Irish corporates.

Majority of these companies should not be rescued by cheaper fresh lending, as their businesses are no longer sustainable in the environment of much slower growth.

However, there is a second argument to be made against increasing the pressure on the banks to lend. Currently, some 140,000 households are in negative equity – with the value of their mortgages exceeding the value of their homes. Factoring in the down payments, stamp duty and closing costs, I would estimate that some 180,000 Irish households are actually in the negative equity territory, implying an insolvency risk rate of ca 9% for homeowners.

Large scale corporate bailouts and credit extensions will inevitably come at the expense of consumers and homeowners. Will this drive homeowners insolvency rates to 21% on par with the corporates? Imagine the number of financially bankrupt families in excess of 315,000…

Public Sector: A Feast Amidst the Plague: Update I

Here is another interesting observation concerning Public Sector earnings.

The figure below clearly shows that wages in the lowest earning categories of public sector fall within 1 standard deviation of the total public sector wage (i.e the average). This disputes an argument that there is any significant degree of heterogeneity in pay within our public sector.

Statistically, this shows that not a single category of workers in the Public Sector (identified by their respective sub-sectors of employment) earn less than the overall Public Sector average.

Indeed, this data (taken from the CSO - see here) proves that within the public sector, the so-called 'low paid' areas or professions enjoy a relatively average rate of pay, with the average itself being artificially inflated by the higher earning categories. In other words, there is no pleading relative poverty for any sub-sector of the public sector employment.

PS: Did anyone notice an apparently bizarre logic our public sector trade unions have taken to in arguing against any cuts in public sector wages?

Well, they are arguing that such a cut would be deflationary (in case you have not noticed, deflation is a new evil). Thus, their argument goes, to rescue our economy out of the current crisis, one should stick to the excessive wage increases granted to the public sector employees under the last Social Partnership deal. But hold on, weren't the same trade unions also arguing that high inflation in the past made it imperative to raise wages paid to the public sector employees?

In other words, ICTU/SIPTU and the rest of them are having it both ways: inflation or deflation, they'll have a pay rise in the name of the nation's economic health...

Have a cake, eat it, and get the rest of us to pay for both?

Public Sector: A Feast Amidst the Plague

According to the latest CSO figures (here):
“Average weekly earnings in the Public Sector (excluding Health) rose by 2.9% in the year to September 2008. The index of average earnings …rose by 3.6% for the same period. Average weekly earnings rose by 1.7% in the year to June 2008 while the index of average earnings rose by 2.5% for the same period.”

Oh, no, I am not making this up. Here is an illustration from CSO's release:Only a month-and-a-half after Mr Lenihan thundered first about saving €440mln in 2008 (he actually ended the year overspending €370mln rather than saving a penny) and €2bn in 2009 (we know where that promise is going) and a month before he launched his ‘patriotic’ tax increases in Budget 2009, according to CSO:
• Public sector wages were still climbing up, while
• Public sector employment… well, shall we let CSO speak on this:
“A total of 258,200 people were employed in the Public Sector (ex Health) in September 2008 compared to 251,100 in September 2007 [a rise of 7,100]. In the year to September 2008 employment in the Education sector increased from 93,500 to 97,900, a rise of 4,400. Overall employment in the Public Sector was 369,100 in September 2008, an increase of 5,200 compared with September 2007. Employment in the Health Sector decreased from 112,800 in September 2007 to 110,800 in September 2008, a decrease of 2,000.”

Chart illustrates…
All sub-sectors of public employment are up! While the rest of the economy is buckling under the weight of a severe recession.

Oh, dear, who can now take our Brian-Brian-Mary Trio seriously?


PS: to our previous post (here):
According to CSO release today, retail sales volumes fell by 1.2% m-o-m in November, with the annual rate of decline of 8.1% (exacerbating a 7.5% decline in October). The last time the annual rate fell to these levels was in February 1984. November core sales (ex-motor) volumes fell by 1.9% m-o-m, and by 7.8% y-o-y. Car sales were down 11% y-o-y. Overall, core retail sales have now fallen - in y-o-y terms - at a rate not seen since April 1975. Consumers are clearly boycotting Brian-Brian-Mary policies and spending only on bare necessities at home, preferring to take their Euros to Northern Ireland, the UK, the Continent, the US or anywhere else where they are welcomed. In doing so, they indeed fulfill their real (ass opposed to Lenihaenesque) patriotic duty of serving their families' needs!


PPS: a fellow economist (hat tip to Brian) just asked (rhetorically) if these figures mean that we might register and unadjusted decline in December retail sails. My view - quite possibly. And January sales, and February sales, and so on, well into a -4.5-6% fall in retail sales for 2009! Laffer Curve is merciless - raise taxes, see revenue evaporate. Brian-Brian-Mary should have been sent to Economics 101 before they were allowed to run the country!

How (not) to spin data

The latest press-release from CSO’s QNHS-based analysis of Q2 2002 – Q2 2008 data on educational attainment sounds self-congratulatory:

“In the second quarter of 2008, 29% of all persons aged 15-64 had attained a third level qualification. The proportion of people with a third level qualification increased steadily over the years since Q2 2002 when the comparable level was just over one fifth (22%). Excluding 15-24 year olds (the age group most likely to be still in education), just over one third (34%) of 25-64 year olds had a third level qualification, and this had also increased gradually annually since 2002 when the level was 25%. … The latest available figures for all EU member states showed that, in the second quarter of 2007, 30% of all 25-34 year olds had a third level qualification. The equivalent figure for Ireland was 44%, ranking the country second in the EU only to Cyprus (47%). The lowest levels of third level attainment were reported in Czech Republic (16%), Slovakia (18%), Italy (19%) and Austria (19%).”

There is more spin in these remarks than truth about the quality of our labour force. Here is why.

Based on the set of three main international rankings, Ireland’s third level education system ranks 22nd out of 38 countries, or 15th within EU27. Less than 20% of our entire crop of third level attendees and graduates come from the universities and institutes that make it into top 500 in the world rankings. Furthermore, CSO own data shows that only 18% of our 15-64 year olds have managed to actually complete a third year degree - a real measure of the ‘third-level qualification’ attainment.

This suggests that only ca 3.6% of our labour force had a real, internationally competitive educational qualification - i.e a Bachelor's degree or above. For comparison, the figure is closer to 9% in the US and 10% in the UK.

Figure 3 in the CSO report shows that Cyprus leads EU27 in the proportion of the labour force with third level qualification. Cyprus actually fails to rank amongst top 50 countries around the world for quality of its 3rd level education. Apart from Cyprus hardly constituting a worthy competitor for the 'knowledge' economy-bound Ireland Inc, virtually all of the countries named by CSO as being laggards to Ireland score better than Ireland in the university league tables. May it be the case that the CSO's (and EU's) methodology for measuring success in education is confusing quantity with quality?

A regression of the proportion of the 3rd level education attainment for 25-34 year olds on the proportion of early school dropouts shows a strongly negative relation between two variables:
For the entire set of countries (EU27): y = -0.2051x + 33.649 R2 = 0.0079
For small EU countries sub-sample: y = -0.2966x + 35.017 R2 = 0.0648
This is logical, as more drop outs should, in theory, imply fewer potential graduates. In both cases, Ireland and Cyprus come up as strong and influential outliers. Exactly the same happens when we look at the positive relationship between the proportion of the graduates with completed secondary education and those with third level qualification.

Now, considering the two equations above, two additional facts, not considered by the CSO, emerge as being of interest to the case of Ireland's education success. First note the difference in the intercepts between the two groups of countries. This suggests that an average small EU state has a higher share of the labour force with thrid level education. Second, the adverse impact of early school drop outs on educational attainment is stronger for smaller countries than for the larger states. In some ways, this again points to some problems with the CSO data, because, as it turns out, Ireland scores almost exactly the average for the smaller EU15 states in terms of the share of the population who failed to complete secondary education. So by both of these facts, Ireland is an outlier - an exception to the rule.

Hmmm… something is not quite right.

One possible explanation of this puzzle is that somehow Irish society is so polarized across the social demarcation lines that a substantial share of population has extremely poor graduation rates for secondary education, while another substantial sub-group has extremely high graduation rates for third level education. But this would not explain the case of Cyprus where income inequality is different in composition and magnitude from Ireland.

Another explanation is that Ireland, and possibly Cyprus, suffer from quality dillution in education at the third level, also known as 'dumbing down' of our universities. Much has been written and said in public about this matter, but the latest CSO numbers may be providing an indirect hint at the extent of the problem. If the vast majority of Irish Universities and third level institutions cannot reach top 500 in the world league tables, an army of the graduates (and, given the CSO methodology, an even bigger army of the 'near' graduates) they produce might just deliver the equivalent of the Chariman Mao's Great Leap Forward in education - massive boost in quantity, at a cost to quality.