Thursday, December 8, 2011
08/12/2011: Budget 2012: Irish Daily Mail
08/12/2011: Budget 2012: Irish Examiner
Wednesday, April 7, 2010
Economics 07/04/2010: Another lesson from Greece
Monday, February 8, 2010
Economics 08/02/2010: PIIGS or PIGS?
This week marked a new low for the euro zone. Despite all the posturing by Brussels officials about Greek deficits and the incessant talking up of the euro by the ECB and the Commission, the events clearly show that the common currency is lacking credible tools to bring order to public finances of its member states. Thanks to the clientilist politicians and the electorate, keen on piling up debt to pay for perks and inefficient public services, the Greeks really blew it. Then again, given their performance over the last fifteen years – inclusive of massive persistent deficits and outright manipulation of official data to conceal them – about the only surprising thing in the ongoing Greek tragedy is that their bonds are still trading at all.
Much more interesting events, related to the Greek debacle, are unfolding in Ireland. Boosted by the factually erroneous, yet ideologically pleasing statements by international observers, Ireland’s image in the euro area has improved significantly since the publication of the Budget 2010.
Which, of course, is out of line with economic reality on the ground. Far from exiting the PIIGS club of sickest euro economies, comprised of Portugal, Ireland, Italy, Greece and Spain, we are now looking like a country to which the wrath of international bond markets might turn next, once Greece is dealt with.
Let me explain.
This week, writing in the Financial Times, a respected economist, Nouriel Roubini has clearly shown just how escapist is the current thinking about the state of public finances in Ireland.
"The best course [for Greece] would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes... This approach is working in Ireland – spreads exploded as public debt ballooned to save its banks, but came back in as public spending was cut by 20 percent."
Professor Roubini’s comment was echoed later in the day by ECB’s President Jean-Claude Trichet who lent unprecedented amount of good will to the ‘right policy choices’ made by Ireland.
Even our Department of Finance has not, officially, claimed such a thing.
First off - Irish fiscal adjustments from the beginning of the crisis to-date are split approximately 50:50 between higher tax burden and ‘savings’. This debunks Professor Roubini’s general analysis of our policies.
But more importantly, it shows that our Government policies have focused on providing fiscal and financial supports to a select few at the expense of the entire economy. Some €70 billion plus of real future taxpayers’ money has been already committed and €10-15 billion more is still waiting to be deployed post-Nama to rescuing Irish banks’ bondholders. Slightly less comfort was given to the developers who will get a three year holiday on loans repayments courtesy of the taxpayers.
In a real world, economic recovery can only start with ordinary households and businesses. In Ireland, public policy assumes that raising taxes and charges at the times of shrinking incomes and revenues to sustain banks bondholders and narrow interest groups within this society passes for ‘doing the right thing’.
International observers might overlook this fact. For them the costs of encountering a deep and prolonged Irish recession are nil. But for us, the spectre of the 1980s is painfully evident.
In contrast to Greece, Ireland has been hit by an unprecedented, in magnitude and duration, economic recession. Our house prices bust and financial assets collapse was deeper than that of Greece. We also are facing a much more severe banking crisis and a significantly more dramatic rates of deterioration in public deficits. Ditto for our unemployment levels and credit contraction rates.
Our sole claim to better health is a substantially lower existent public debt burden. Alas, this too is optical. In real per capita terms, total levels of debt in Ireland (combining public and private debts) are several times greater than those in Greece.
Even when it comes to budgetary adjustments – as far as Governments plans go – the Greeks are ahead of us. Starting from marginally higher deficit in 2009, the Greeks are planning to bring their deficit to within 3% of GDP limit by 2012. We are planning to do the same by 2014. Of course, both plans are unrealistic, but whilst the EU Commission will attempt to force the Greeks to comply with their target, no one will be closely monitoring our Government’s progress.
In summary, we are nowhere near exiting the PIIGS club.
But let’s take a look at the ‘Love the Irish Policies’ media circus going on in international press. Contrary to Professor Roubini statement, Irish Government has been unable to achieve meaningful cuts in public spending to-date. Instead, we delivered a reallocation of some funding from one side of public expenditure to another. ‘Cuts’ in majority of departments have been simply re-diverted to social welfare and Fas.
By Government-own admission, there will be no net reduction in public expenditure in Ireland since 2009. Department of Finance’s "Ireland – Stability Programme Update, December 2009" provides some stats. In 2009, Gross Current Government Expenditure in Ireland stood at €61,108 million. In 2010 it is budgeted to reach €61,872 million. The latter figure does not include the cost of recapitalizing the banks post-Nama. In 2011-2014 the Government is projecting the Gross Current Expenditure to rise steadily from €63,518 million to €65,768 million.
To Professor Roubini this might look like savings, but to me it looks like the Government continuing to leverage our economic future in exchange for avoiding taking necessary medicine now.
The only reasons why our deficits are expected to contract from 2011 through 2014 is because the Government has been slashing public investment, raising tax burden and is banking on a robust recovery after 2010.
Overall, DofF plans for a 2.8% cut in the General Government Balance in 2010, and that will leave us (per their rosy forecasts on growth and tax revenue) at 11.6% deficit relative to GDP, down a whooping 0.1 percentage point on 11.7% deficit achieved in 2009. Adding expected costs of banks recapitalization, our Government deficit can easily reach beyond 14-15 percent of GDP this year. Greece is now aiming for 8-9% deficit this year under a watchful eye of the Commission. Do tell me Budget 2010 qualifies us for being treated as a stronger economy than Greece.
Stripping out its interest rate bill, Greece is planning for lower per-capita state borrowing in 2010 than Ireland. But Irish Exchequer is planning to raise its borrowing this year by 3%. If international observers are correct, why would the Government that managed to cut its spending by 20% increase its borrowing? That would only make sense if the revenue is expected to fall by more than 20%. Yet Budget 2010 assumes tax revenue decline of only 4.7% in 2010 and an increase in non-tax revenues.
So what has Irish Government done to deserve such a sweet-heart treatment from the EU and Professor Roubini?
One word comes to mind – smart marketing. Budget 2010 simply took €4,051 million from one Government pocket and loaded it into another. Then, the Government promptly reversed itself out of some of the higher profile cuts, such as those imposed on higher earners in the public sector. Even at the highest point of estimates, the savings – before they get cancelled out by rising spending and falling revenue – amount to the total of 6.42% of the Gross Total Expenditure in 2009.
After 2 years of the deepest economic crisis in the euro area, we are now facing one of the heaviest upper marginal tax burdens in the developed world, and a deficit that is simply out of control. Hardly the road map to a recovery.
Tuesday, January 19, 2010
Economics 20/01/2010: Long term comparatives for Ireland
First output gap as percent of potential GDP
There is really no doubting who's worse off in this picture. And notice how much more dramatic is our output gap volatility compared to, say, Austria - another small, but more stable economy, despite it having a massive exposure to high growth and high volatility Eastern and Central European countries.
Next, we have GDP per capita.
Several features of the chart are worth highlighting.
Obviously, Iceland is now on the path, per IMF to close the gap between themselves and us in terms of GDP per capita. Dynamics-wise, it is expected to do better relative to Ireland than it ever did in the period since the late 1990s through the bubble. Taking medicine on time and in full, obviously pays for Iceland. Back in 1999 Ireland moved onto a path of GDP per capita in excess of Iceland. In 2009 it moved on the path of GDP per capita converging with Iceland.
Who's doing better here? By the end of 2014, Iceland is expected by the IMF to fully recover from the crisis, reaching peak GDP per capita once again, after a shorter recession than the one enjoyed by Ireland. And Iceland will do so with faster growth in population than Ireland will (see later charts).
Under DofF dreamy assumptions, Ireland too will reach its pre-crisis peak by 2014, but it would have taken us a year longer to get there than Iceland. And this is under DofF assumptions.
Now, I also provide my own forecast - somewhat gloomier than that of the Government - which implies that i do not expect Ireland to reach the pre-crisis peak income per capita any time soon. And this dynamic will be paralleled by a slower growing population.
Also, do remember - our GDP is not a measure of our income (GNP is), while for Icelanders the two measures are more closely related.
Next inflation as measured by CPI:
Do tell me we are just fine with 5% deflation in the current cycle. Not really, folks. In order to get us back to price levels that imply competitiveness, we need a good 40% deflation if not more.
Unemployment - the one that we are being told is getting better now that 'the worst is already behind us' per official Government view:
Again, think Iceland and Greece. Greece is a good one in particular - their unemployment was high since the late 1980s. Ours was low since the mid 1990s and sub-zero since 2001. But, thanks to our 'head-in-the-sand' economic policies during the current crisis - we are now at the top of the league.
Demographics - some say this is our saving grace, the golden 'get-out-of-the-slump' card:
Nothing spectacular that I can spot here. And these are IMF projections that lag in incorporating what we, on the ground already know - the rapid depletion of our foreign workers' population and waves of young Irish people leaving the country.
Let's take a look at employment (as opposed to unemployment) as % of the total population. basically, the higher the number, the lower is the country dependency ratio (in other words, the greater is the number of people working than the number of people they support):
We were doing pretty well - just below Iceland and Switzerland. Post crisis, Iceland will retain its second best position, but we will slide below Lux. Again, this is in the environment where our population will be growing slower than that of Lux...
General Government Balance:
Well, yes - per Brian Lenihan we have taken the necessary steps... Did we? How is fooling who here? Iceland will be ahead of us with default and without a mountain of international bondholders' and depositors' liabilities on the shoulders of its people. We will both, destroy our public finances and our private households' finances as well. All for what? To make sure we do not upset banks bond holders? But wait - these figures do not reflect Nama and its cost. They do not reflect future bank recapitalisations. Were they to do so, our Government Balance would have fallen way beyond 16-18% mark.
But let us take a different look at the same figure:
Now, remember all the talk about Charlie McCreevy being a profligate spender as the Minister for Finance. Actually, not really. Over his tenure - longer than that of his successor, McCreevy presided over relatively mild deterioration in fiscal position. Primary balance under McCreevy in cumulative terms was close to break even. Under Minister Cowen things spun out of hand. Noticeably, Minister Lenihan is doing a much better job than his predecessor, although it is hard to say whether he is doing it because he actually believes in some sort of fiscal discipline or because he simply cannot borrow all the money he would like to borrow.
Current account balance:
For an economy that is staking its survival on exports (and we really do not have much of hope of doing otherwise), we are not looking all too strong in 2010-2014 projections by the IMF. Iceland, in contrast, is looking mighty alright relative to us, having undergone massive devaluation. Again, our deflation at home is simply not enough to compensate for the fact that we cannot devalue the grossly expensive euro.
Let me take you through more comparatives. Back to Government deficits. Now, recall there are two components to deficit - structural (due to chronic overspend) and cyclical (due to a recession).
Again, notice how Greece and Austria are on virtually identical path, although Greece is above Austria. This means that on average, the share of their overall deficit that is structural is relatively the same. If Greeks were to cut their structural deficit relative to its position today, their overall deficit will decline by a lower percentage than the same drop for Ireland. In Ireland's case, we have smaller cyclical deficit than the Greeks do, but greater structural deficits. Relative to Austrians, we are simply a drunken sailor hitting the first pub on the shore.
Take a closer look at the Irish data alone:
In the 1980s through late 1990s - much lower structural deficits than since 1998. Why? I guess Bertie really was a profligately spending socialist of the old variety.
Last chart: just to drive home the same point as before: Note the dramatic deterioration in structural balances under Mr Cowen - throughout his years as Minister for Finance, he was spending not only the money he had (shallower surpluses than his predecessor), but also the money he did not have (deeper structural deficits), leveraging lavishly future generations' wealth. Mr McCreevy, in contrast, really was spending what he had, with structural deficits starting to cause problems in his tenure only around 2002.
And one last point to make - notice how our structural deficit has caught up with its 5-year moving average line. This suggests that even in the Budget 2010 we still did not do enough to reverse longer term trend leading us deeper and deeper into permanent insolvency.
Paraphrasing Fianna Fáil's 2002 general election slogan: "A Little Done, More To Do"...
Sunday, November 22, 2009
Economics 22/11/2009: News Flash - our taxes are already killing FDI
Before that, a quick news flash - my source close to DETE has informed me last week that in September-October this year three large multinational companies currently not present in Ireland have told our international investment development agency that they have no interest in locating in Ireland. These statements came after several months of negotiations to attract these companies into Ireland. Significantly, all three indicated that the upper marginal tax rate in Ireland, which inclusive of levies and charges rises to a whooping 56% of individual income was the main reason for them not to locate their European headquarters here, as they deemed this level of tax on executives' earnings to be prohibitive.
As Ireland is facing the prospect of one of its toughest Budgets in history, the debate about what to cut and by how much has firmly displaced all other issues on the news agenda. Different views, arguments and policy proposals abound. Virtually all side one way or the other with the idea that any reduction in public spending will be deflationary in this economic environment. Cut public deficit financing, say proponents of tax-and-spend or borrow-and-spend policies, and you will be cutting consumption, triggering a decline in GDP, and more layoffs.
This argument is not new. Many economists, let alone policy pundits, subscribe to it. But is it really true? If the Irish Government were to reduce public consumption or state wage bill today, will the Irish economy crash?
The debate centres on the question as to how large is the fiscal policy multiplier. To understand it, suppose that the fiscal multiplier is greater than 1, say 1.5. In this case, a €1.00 increase in government purchases raises the aggregate demand for goods and services in the economy by more than one euro, or in example above, by €1.50. If the original euro was borrowed at 5% per annum, then the net return to the economy is 42.9%. Sounds magical? If this indeed were true, economic prosperity for all can be achieved by simply endlessly running ever-rising deficits to finance more and more public spending. Enter SIPTU/ICTU/CPSU programmes for State spending. Clearly something is amiss in this logic.
But forget the theory, perhaps fiscal policy alchemy works in practice?
Well, even in the case of the US – the most thoroughly researched economy in the world - there is confusion as to what exactly deficit financing of public expenditure does in a recession.
In a recent research note Professor Christina Romer, Chair of President Obama’s Council of Economic Advisers, asserted for each $1 spent by the Federal Government in a recession, US economy grows by $1.95. So far so good – borrowing at, say 5% per annum and getting 51.3% return makes sense. So much so, that her own employer – the said Council of Economic Advisers – thought this paper was a grand candidate for publicly justifying President Obama’s stimulus package.
The problem, of course, was that Professor Romer’s estimates did not fully for the fact that the largest part of President Obama’s stimulus came in the form of tax cuts, not spending increases. The former accounted for roughly $66bn of the total spending of $151.4bn in March-August 2009, while conventional public spending accounting for just $30.6bn. The rest of stimulus was taken up by aid to the states ($38.4bn) much of which went to offset earlier local tax increases and Government investment ($16.5bn).
In response to Professor Romer, Professor Robert Barro of Harvard University argued in January 2009 that historically, US fiscal multiplier was very close to 1, suggesting that deficit-financed spending earns no real economic return. And Barro’s findings are echoed by an earlier study by Roberto Perotti of Bocconi University, Italy. Perotti looked at fiscal multipliers for the OECD countries between 1960 and 2001. His main conclusions were that post-1980 there is no evidence of fiscal multipliers being in excess of 1. Over time, with a 5% coupon on a 10-year Government bond, deficit financing for Ireland Inc today, under Perotti’s findings will end up costing our economy at least 62 cents on each euro spent net of any benefits we might receive from growth. Furthermore, Perotti found evidence that government spending stimuli hurt private consumption and investment, whereas tax cuts do not. This suggests that cutting taxes, although not necessarily more productive than a fiscal stimulus in the short run will at the very least be less costly to the economy in the longer term.
So dynamic effects of deficit-financed fiscal stimulus over time do matter. And here lies the crux of our debate: dynamic effects depend on country characteristics. Majority of studies on the matter of fiscal multipliers were carried in the US – a country that hardly resembles Ireland for several reasons. Firstly, it is a large and a relatively closed economy. Secondly, it has independent monetary policy, prints its own currency and has a global market for its bonds. Ireland, in contrast, is a small open economy, with no monetary policy independence, extremely tight and saturated markets for its bonds and with exchange rates that are flexible vis-à-vis its main trading and investment partners (the US, UK and the rest of the non-euro world).
And this brings us to the last point of our tour de force through the world of fiscal multipliers and deficit-financed state spending programmes. To make the most accurate assessment of the potential effects of the public sector cuts proposed for the Budget, we must consider empirical evidence for countries similar to Ireland. A recent (October 2009) study published by the Centre for Economic Policy Research looked at 45 countries (20 high-income and 25 developing), spanning 1960 through 2007. What the authors found confirms the results attained by Romer and Perotti, and paints a picture of just how dangerous the deficit financing myth can be for a country such as Ireland.
For a small open economy, like Ireland, the study found cumulative total fiscal multiplier starts with a negative (yes, a negative) -0.05 effect on economic growth and in the long run (over 6 years) reaches a negative -0.07. In no time does the average cumulative multiplier exceed 0.4%. Now, add to this a realisation that Irish economy operates in the world where the Euro is in a virtual free-float against the Pound Sterling and the US Dollar. The same study estimates that for economies with flexible exchange rates, the impact effect of fiscal stimulus is -0.04 and the cumulative long-run effect is -0.31.
This means that were we to pursue a policy of higher fiscal spending based on deficit financing, as the Men of the Liberty Hall suggest, we would be facing immediate losses of at least between 4-5 cents on each euro of the entire stimulus. Over time – say by around 2013-2015, these losses will accumulate to something in the neighbourhood of 31-40 cents on the euro per annum. And this is before the cost of financing these deficits is factored in.
Even were ICTU/SIPTU were right on our ability to raise funding without any cost to the real economy (although their proposals would imply severe tax hikes for ordinary men and women of this country), Irish economy would still be wasting money if transferring wealth from the so-called rich (aka pretty much everyone with a decent job) to public expenditure.
Love it or hate it, but real world economics simply has no room for our Social Partners’ latest ideas on fiscal management.
Box-out:
At a recent conference, a French colleague asked me if Ireland is a low tax and low public spending economy.
The only way to answer this question is to consider the overall size of the Government expenditure in Irish economy. Back in 2008, Irish Government spending accounted for approximately 48% of our GNP, or one percentage point above the EU average and about half a percentage point above the UK. Forget for a moment that the UK has a functional and a sizeable military.
Focus on 2009 numbers. Due to continued increases in public spending throughout
this year, and to a rapid decline in our GNP, Irish Government spending is likely to account for between 53% and 54% of our domestic economy. In other words, over half of all goods and services supplied in Ireland is being swallowed by the State.
To put this number into perspective, the heaviest taxed economy in Europe in 2008 was Sweden, where the ratio of public spending to domestic economy was just over 53%. Yet, navigating through the recession, Swedes cut their taxes in 2009 as we raised our. Thus, by December 31 this, Ireland will be the holder of the dubious title of the heaviest taxed economy in the EU.
Now, give a thought another fact. Top personal income tax rate in Denmark in 2008 was 59%, in Sweden - 56.4%. In Ireland it is 56% after April 2009 Budget. Thus, we now have the third highest income tax band in Europe.
All of this means that Ireland is heading for a grim Christmas sales season shackled not by low consumer confidence, but by a lack of after-tax disposable income.