Economics 9/10/10: Path to reforms

This is an unedited version of my column in October 2010 Village magazine:

The events of the recent months have clearly shown that the current policies path leads to a continued status quo. This is the sole and unavoidable conclusion currently being reached by all independent analysts and commentators on either side of ideological divide. It is a non-partisan concern that informs the rising tide of discontent within the Fiana Fail and Green parties, recent changes within Fine Gael, positions of all other opposition parties, and indeed the entire electorate – as reflected in the opinion polls.

At this junction, there is no longer any need to enlist numerous factual manifestations of this reality – they are all around us, expressed by politicians and ordinary citizens. The tide of international opinion concerning the prospects for Ireland should the current policies persist has turned against us. The IMF (since April 2010), the EU Commission (since May 2010), markets makers and participants – all have put out challenging assessments of Irish Government official projections for the recovery. Irish banks – far from being repaired by Nama – just keep asking for more taxpayers bailouts with a frightening regularity of a drug addict returning to a methadone dispensary.

It is, therefore, time to challenge the existent policy consensus. It is the time to put forward proposals for reforms, to debate real alternatives and to provide those political parties and individual politicians willing to champion change with new ideas to energise the electorate.

Here is my own set of ideas – the offshoot of the ongoing ‘Manifesto Project’ I have decided to run on my blog.

To preclude any ‘kill the messenger’ objections, allow me to state that the following is just a set of policy reforms proposals that any party or politician are welcome to adopt in part or as a whole and put to the electorate.

Fine print aside, let me outline the backdrop to the policies – the backdrop of the specific crises we face as a nation. The Irish economy has been hit by a Perfect Storm that combines:

• a deeply rooted crisis in public finances;
• a structural collapse of the banking sector;
• an unemployment crisis stemming from the collapse of employment and jobs creation;
• a competitiveness crisis that is not limited to wages and labour costs, but the cost of living and doing business;
• the crisis in the quality and efficiency of domestic services - dominated and restricted by the excessive market power of the incumbent state-owned and state-regulated oligopolies.
  

These crises have been exacerbated by the Government policies since 2008. These policies have saddled ordinary families and individuals (regardless of whether they work in public sector or private sector, employed or unemployed, young or old) with the full cost of stabilizing vested interests and elites. This manifested itself in rising tax burden, falling provision of public services, lack of reforms in banking and public sectors. The resulting devastation of private entrepreneurship and businesses, contracting investment and availability of operating capital, a catastrophic lack of confidence in economy are the corollaries. The accompanying spikes in unemployment and businesses failures, and a hike in precautionary savings are additional manifestations of these.

The current crisis has clearly shown that the corporatist state - where vested interests, including Political, Business, Social and Environmental collude with the state to set economic and social preferences and priorities - is morally, politically and economically bankrupt. I believe that Irish democracy cannot be surrendered to the vested interests, no matter how broadly-based or highly minded they might be.

There are only two ways forward from this status quo. The first is the path we are travelling – the path of a generations-long and painfully deep crisis of stagnation and declining standards of living. The second one is a path of structural reforms aimed at realigning the current political system to serve the interests of the ordinary citizens and residents of this land.

Such a reform is also a disruptive and a painful one. It can only be achieved by creation of an alternative to the existent policies and structures.

In my view, the agenda for reform should champion the rights of ordinary citizens – consumers and taxpayers – to counterbalance existent system that promotes the interests of the vested pressure groups and elites. It must, therefore, include changes to the state political and governance systems, to the principles governing provision of the public services, to the systems of our private markets and, lastly, to the rebuilding of our financial system. For the sake of brevity, I will focus on the first two objectives.

Changes to political and governance systems

The core changes to the political and governance systems must put transparency and accountability principles of governance to the front. This will require creation of automatic systems of disclosure and control that are not subject to tampering by individual office holders. It also requires ending Social Partnership, delegating all authority, and the responsibility, for developing, implementing and monitoring economic and social policies solely to the Legislative and Executive branches of the State.

In terms of transparency, default setting must be public disclosure and unrestricted free access to all data not subject to the secrecy of the state considerations. Sensitive data should be published with exclusion of sensitive information and identifiers, until the time when it can be published in full.

Accountability requires that performance and productivity metrics should be designed and refined through experience for all branches of public sector. All earnings in the public sector should be linked to individual productivity.

Local authorities must be reformed, reducing the overall number of local authorities to, say, 7, covering: West & North West, South, Greater Cork, Greater Dublin, Greater Limerick, Greater Galway and Border & Midlands.

Seanad should be given real powers of the upper chamber and be elected directly by the people of Ireland, with equal representation for each of the 7 geographic region outlined above. Dail should be reformed by reducing the number of TDs and to cover both local and national mandates. The former will preserve a number of seats allocated locally, while the latter will allocate some proportion of seats based on national polls.

Both chambers along with the Executive should accord no privilege to their members that will put them above the ordinary citizens of the state. This will require abolition of unvouched expenses, enforcement of the Benefit-in-Kind principle of taxation and removal of the un-provisioned pensions entitlements.

All state purchasing should be carried on-line, made public and transparent and subject to annual audits by independent external board.

State services reforms should include the separation of provider of services from the supplier of services. This means that the Irish state should aim to be a purchaser of services, e.g. health care and care for the disabled, for those who cannot afford them. But the State should not own service providers. Instead, public services can be supplied by mutual, private for-profit or non-profit providers. Transition to such an arrangement will require significant training and logistics support for current employees.

Higher education should be based on fees set by universities and overseen by the Department for Education. The State should set up (with participation of charities and other private agencies) a number of funds that will provide financial aid to students based on need (with an objective of creating an equal opportunity for all qualified students to undertake studies) as well as merit (with an objective of rewarding real achievement). A further system of state-guaranteed student loans should be set, subject to independent oversight and audit.

The state should focus significant resources on the need to improve and strengthen provision of universal early, primary and secondary education in order to achieve maximum equality of opportunity for the children independent of the social and/or economic status of their parents.

Changes to fiscal systems

There is a need to rebalance the burden of taxation in the economy to deliver on three core objectives. First, the taxation system should be fair, transparent and protected from abuse. Second, it should involve participation from all agents in the economy. Third, it should not attempt to pick winners and leave in its wake the losers.

With these objectives in mind, I would suggest adoption of a flat rate income tax system with single personal standard deduction plus a child allowance, potentially linked to the level of unemployment benefits. All discretionary tax breaks should be removed, including any tax incentives for farming and any other economic activity. Non-residency limits should be set to reflect the needs of Irish citizens working abroad and commuting home – e.g. a limit of maximum 124 days annually to cover all weekends plus standard vacation. A move to a single rate income and corporate tax can also be used to deliver full equalization in taxation between workers, entrepreneurs and businesses.

Existent Byzantine system of indirect taxes and levies is to be simplified with a view that all such charges should be based on user fee principle and be fully ring-fenced to finance provision of services covered and mitigation of adverse externalities (e.g. environmental degradation etc) generated by these services.

There is a need for having strong, but life-time capped, welfare provisions. This will provide a sufficient insurance cover for all able-bodied working age adults in the country to a cumulative maximum of 7 years over the life-time. Provision of welfare supports to those unable to work due to health or family circumstances (e.g caring for a disabled relative etc) should be exempt from life-time limits.

The basic social insurance pension reform should ensure that the elderly are covered by s sufficient safety net, but the working-age individuals are encouraged to privately invest in their pensions.

Wages for politicians and senior public servants are to be tied to the National Disposable Income in order to create a direct link to the overall levels of welfare in the society (including that of the unemployed and socially vulnerable). There should be no bonuses or discretionary pay and all public sector pensions should be converted to a Defined Contribution system with generous matching from the employer.

Government spending should be benchmarked to a specific range of GDP (for example – 35-38%). A balanced budget should be maintained over every 3-year period. This allows for small emergency spending boosts in recessions, but prevents spending sprees before the elections and other abuses of the public funds.

All quangoes, except those with immediate independent oversight authority (e.g FR and Competition Authority) are to be abolished and their functions transferred to the respective departments. Responsibility for governance and management must rest with the Government.

There is a need for a fully transparent tax on land values (LVT) in order to finance public infrastructure investments and provision of local services, including environmental protection and improvements. I would suggest that the revenue from LVT should be split 50:50 between central & local authorities. Local authorities should be allowed to vary their rate of LVT within reasonable parameters. For example, if LVT is levied at 1% pa, the local authority can be allowed to charge between 0.25% and 0.5% as it deems suitable, while the central government will collect 0.5%.


After three years of ever-deepening crises in political, economic, and banking spheres, Ireland now faces a stark choice between two alternatives. We can, as a nation, elect to either follow the status quo path that leads to a stagnation. Alternatively, we can choose to challenge the existent policy consensus to champion the rights of ordinary citizens – consumers and taxpayers.

Economics 6/9/10: Summer of missed opportunities

This is an unedited version of my column in the current edition of Business & Finance magazine.


To those of us who practice economics in the real world of markets and private enterprises, the homo economicus is a species endowed with the picture of the past but a vision of the future. To academics, economic reasoning is almost exclusively descriptive. This difference is not about the power or accuracy of forecasts. No one, familiar with the field would ever vouch in economists ability to deliver reliably accurate and useful predictions of specific outcomes.

Last few weeks offer a somewhat unusual, quasi-experimental insight into the future for Ireland Inc. July and August are the doldrums months in the giant global markets. Whatever happens around these months in Ireland, therefore, says more about our own capabilities and failures than what takes place in the rushed days of September and October.

So here is a picture of Ireland, then, in the Petri dish of our own policies.

Courtesy of the independent analysts first, followed by the IMF’s July report, we have learned that Irish Government deficit is doing the opposite of what the Government has hoped. Department of Finance projections for 2010 pencilled in 11.6% borrowing requirement for the Exchequer. May forecasts by the independents was for a figure ‘closer to 20%’. IMF July prediction is 19.9%. And that is before the latest spill of Anglo and INBS ‘bad’ loans news.

Overall tax receipts are now running €1,536mln below 2009 numbers for the first seven months of this year, and are still way off 2008 numbers by €5,520mln on 2008. This means we are now 8.22% below 2009 and 24.35% on 2008. Vat is €483mln or 6.9% below 2009, and €2,453mln or 27.5% behind 2008. And this is after the massive Vat boost from automotive sales increases driven predominantly by the vanity 2010 plates. Income tax shows a similar pattern: down €537mln on 2009 (-8.45%) and €1,060 on 2008 (-15.4%).


On the expenditure side, savage cuts to capital investment account for virtually all ‘savings’ achieved to date. This is fine, were the Government to undertake significant reforms in the current spending in the forthcoming Budget. However, all indications are that it will not do anything of the sorts.

The Machiavellian Croke Park deal enshrined in stone the very structure of pay and employment practices that makes up for one third of our gargantuan public spending bill. We even had a veritable drama performance befitting Abbey from the ICTU/SIPTU/CPSU leaders who worked tirelessly to ‘sell’ the deal to their members. The end result was the complete shedding of public sector liabilities onto the shoulders of ordinary taxpayers.

Social welfare reforms can at the very best be minimal in the current climate of chronic and continuously rising unemployment. In addition, timing of Liver Register increases suggests that many of the unemployed are close to exhausting their job seekers’ benefits and redundancy payments, pushing them deeper into the welfare trap. Add to this the fact that de facto the ruling coalition has no political capital left to fight its corner on a deep reform, and you have only one conclusion to make about the next Budget: prepare for savage tax increases all ye who hold a job!

This signal to the rest of the world and our own entrepreneurs and the workers in the productive (i.e. exporting) sectors is inescapable. Pro-business Ireland will hike your taxes to make you pay for the ‘industrial peace’ achieved in the public sector wards.

And it is highly unlikely that such policies can lead any significant stabilization of the Exchequer finances at any rate. Tax increases have been significant since the beginning of the crisis, yet tax revenues continue to decline. The fabled ‘stabilization’ across some tax heads to-date has been nothing more than the slowdown in the rate of tax receipts decline. There is no tax receipts uptick. Meanwhile, expenditure side remains worryingly sticky. The end game here is that the IMF (and even our own stockbrokerages – not exactly the paragons of critical assessment of the Government’s official position) are now predicting 2015 deficit to remain at ca 5.3% of GDP, more than 1.8 times the size of the deficit we promised to deliver to the EU Commission back in December 2009.

To put even more sparkle into Ireland Inc’s already shining portrait of competitiveness, the semi states are now desperately searching for any possible ways to beef up their revenues. Electricity costs went up to support such environmentally insane practices as drainage of bogs and burning of peat. As Richard Toll of ESRI summarised one side of Minister Ryan’s policy Bermuda Triangle – we are dumping a massive subsidy to producers of some of the most polluting energy the mankind can have. Transport costs are continuing to rise. All state-controlled sectors continue to show positive inflation through the entire crisis.


The other two sides of the said triangle are equally internecine. Firstly, hiking energy costs – one of the most frequently cited obstacle to our cost competitiveness – during a recession is equivalent to an economic sabotage. Secondly, the only real beneficiaries of this scheme will be semi-state companies, where ‘jobs creation’ costs multiples of what it costs in functional exporting sectors. In other words, given the ESB average rates of pay and value added in this economy, spending €85 million that latest price hikes will net the company in straight subsidies can ‘create’ roughly 3 times fewer jobs than using the same funds to support, say, a new pharma or IT firm entry into this market.

In the mean time, Irish banking sector continued to take on water. Losses in AIB and Bank of Ireland came to cumulative €3.9billion in the latter and a whooping €2bn in just six months for the former. Within days after their respective H1 2010 results announcements, both banks were exposed as having underreported their true loss by a cumulative €817 million thanks to a timing loophole. Anglo and INBS popped their ugly heads out of the somnambulistic slumber to ask taxpayers for €1.9 billion more in funds. Hence, within a span of just 4 months (post March banks pledges made by Minister Lenihan), Irish taxpayers were presented with more than €2.7 billion in new liabilities. At this rate, banks demands on our cash, that Messrs Cowen, Lenihan and, now, Honohan claim to be ‘one-off’ measures, will be running at an annualized rate of €8 billion – or over 26% of our entire 2010 tax take forecast by the Department of Finance.

All of the Ireland’s six state-guaranteed banking institutions remain firmly behind the reality curve when it comes to provision for future losses. Something that the Government appears to accept without a challenge, suggesting that instead of being an active large shareholder (and in the Anglo and INBS cases – the sole shareholder), our state is just letting the banks go on with the business of denying the obvious. Even the stockbrokers at this stage have stopped covering the banks with deeper analytical notes, resorting instead to a quick overview of the interim announcements.

Looking at independent analysis, through the cycle losses in banking institutions are expected to total €50-53 billion in total. This implies additional losses in the system of ca €22-25 billion, split between Anglo further losses of €9-12 billion, INBS losses of additional €2-2.3 billion, AIB further demand for capital in excess of already pre-announced to the tune of €8 billion, Bank of Ireland’s additional €2 billion and EBS €1 billion.

These estimates are based on the balancesheet analysis performed by the banking expert, Peter Mathews and my own modelling using past property and asset markets busts in the OECD, plus updated information from Nama and banks’ own results. The fact that the two estimates virtually converge by institution and in the aggregate gives us more comfort that they are closer to reality than the ‘hit-and-run’ numbers being produced by the banks and official analysts.

All in, my prediction is that Ireland’s state and quasi-state (e.g. Nama) debt pile will grow to over €210 billion by 2014, which puts into perspective the latest ‘successful’ auction of Irish bonds. At the yields achieved, financed with benchmark 10 year bonds, the debt accumulated through the deeply flawed banks recapitalizations and Nama, plus egregious current spending deficits will impose an annual interest bill of €11,310 million our economy. That’s right – by 2014 we are risking paying out more than 33% of our entire 2009 tax revenues in interest charges on the debt.

Adding insult to the injury, the Government has passed every opportunity presented to it so far to impose meaningful reforms on Irish banks. The latest missed opportunity came with the extension of the banking guarantees through December 31, 2010.

At the point of granting this measure to the banks – this time around absent the duress of an immediate crisis – Minister Lenihan could have simply required the banks to adopt deep changes in their operational models and strategies. Such a list could have included the following Nine Steps Reform Plan:

1. Require banks to negotiate significant haircuts on subordinated and senior bond holders, including debt for equity swaps. Time frame – 3 months;
2. Require banks to prepare detailed equity issuance proposals. Time frame – 1 month
3. Require banks to prepare binding estimates of expected future losses through 2012 (3 months) which can serve as a benchmark for board performance on annual basis going forward;
4. Require banks to reform their boards and board members reimbursement to be tied into long term performance by the bank (3 months);
5. Require banks to create independent strategy, risk and operations oversight and advisory committees with the power of direct reporting to the Boards and external strategy and risk audits of the annual results (3 months);
6. Require the banks to commit to a full root and branch reform of upper management (3 months);
7. Force banks to accept salaries and bonus caps on all senior management and board members (1 month);
8. Require banks to achieve conversion of existent outstanding mortgages to a tracker rate of euribor plus 225 bps (allowing the banks a ca 140-155 bps margin on all loans) whenever such a conversion is requested by the mortgage holder (6 months);
9. Actively engage in the process of renegotiating mortgage contracts terms (e.g. maturity and payment schedules) with distressed households, under direct oversight of the Financial Services Ombudsman

At the time of public debate concerning the Guarantee extension, I made the above proposal public and brought it to the attention of several senior members of the ruling coalition. Despite this, and despite a clear cut need for deep reforms of the banks operations and strategies, Minister Lenihan simply opted to walk away from using another opportunity to change the way Irish banks are run.


All in, the summer of 2010 has proven to be a season of missed opportunities and foregone reforms. Whether in academic, or in practical economic analysis terms, this sets the stage for only one outcome to the rest of the year. Instead of engaging pro-actively in building the future of this economy, our leaders have taken to a role of being passive observers on a sinking Titanic of domestic non-exporting economy. The cost of this inaction is likely to manifest itself through a Japan-styled long term recession and a rising burden of the state and its clientele (the banks and semi-states-dominated sectors) on the society at large.