6/8/15: Irish Services Activity Index: June's Belated Sell-in-May

In previous post (link here) I covered Services PMI for Ireland for July.

To remind you: we are witnessing a massive boom (according to the PMI data) in Services, with overall sector activity readings at 108 and 109 months highs in June-July. In addition, based on quarterly averages, Services in Ireland should have been expanding at a break-neck speed non-stop from 2Q 2014 through 2Q 2015, with 2Q 2015 marking small acceleration in an already formidable speed on 1Q 2015. Effectively, over the last 3 quarters, PMIs have been signalling very high rate of growth in activity, with rate of growth being relatively stable over time.

Now, let's take a look at the latest quarterly data from CSO covering actual activity in the Services sector through June 2015.

Overall Services Sector activity index for 2Q 2015 rose 2.3% y/y, which is markedly down on 9.6% y/y growth recorded in 1Q 2015 and marks the slowest speed of Services sector expansion since 1Q 2014. This simply does not correspond to the PMI data readings. In fact, growth has been quite volatile over the last 5 quarters, and again, not consistent with the PMI signals.

As chart above indicates, Services sector growth fell sharply in 2Q 2015 falling below the period average (from 2Q 2014 on) and below the upper limit of statistical significance relative to the historical average rate. Contrary to the PMI signals, three out of six last quarters posted growth within historical averages and well below the period average when PMIs were hitting record highs.


Looking at the key sub-components of the index:

Domestic services sectors (Wholesale & Retail Trade, etc, Transportation & Storage, and Accommodation and Food, along with Administrative & Support services) posted an average rate of growth of 5.3% y/y in 2Q 2015, slower than both 4Q 2014 and 1Q 2015. Still, 2Q 2015 growth was the third fastest in 8 quarters. Over the last 6 months, domestic services managed to average expansion of 7.14% which is a major uptick on previous 6 months period when domestic services sub-sectors grew on average 5.40%.

Information and Communication services index posted a decline of 11.4% y/y in 2Q 2015, the first drop in the series since 4Q 2011 and the sharpest drop in the series on record. The sector is so skewed by activities of MNCs that not much can be determined out of these figures. Still, this drop brought past 6 months growth down to -1.8% against previous 6 months' growth of 6.5%.

In contrast to ICT sector, Professional, Scientific & Technical services sector posted a rise of 6.1% y/y in 2Q 2015, confirming yet again that there seems to be no serious correlation between activity in one side of our 'smart economy' and the other side of the same, despite endless droning on from our politicians and trade bodies about an alleged fabled link between the two sub-sectors through R&D and innovation.

It is worth noting that the sub-sector of Professional, Scientific & Technical services has been effectively whipped out by the crisis: over 2009, index of sub-sector activity averaged 118.88. This fell to 87.93 for the last four quarters - a decline of 26%. In a sense, our Professional, Scientific and Technical services 'did Greece', confirming yet again the deeply engrained culture of innovation and research in Irish economy. Of course, over the same period of time, Information and Communication services activity rose 35.1%. Go figure…

Despite all the issues highlighted above, the good news - as shown in the last chart - is that all three broadly-defined Services sectors have so-far been on a converging path prior to 2Q 2015 since roughly 1Q 2014 - as signalled by the compression of the period average lines. This, of course, reflects the belated return to growth in Professional, Scientific & Technical Services from 3Q 2014 on.

21/3/15: Irish patents filings Q4 2014

Latest data on Irish patents, courtesy of NewMorningIP.com: chart below shows a decline in total patents filings in Q4 2014 compared to Q3 2014 with Q4 2014 patents counts at 699 down from Q3 2014 count of 786. Of these, Irish invention patents were down to 321 in Q4 2014 from 331 in Q3 2014, but up on 236 a year ago. In Q4 2014, Irish inventors accounted for 45.9% of total Irish patents filed, with Irish enterprises and individuals filing only 247 patents - the lowest for any quarter since Q1 2014, but ahead of the disastrously poor performance in Q4 2013 (188 Irish enterprises & individuals patents). Irish academia produced 74 patents in Q4 2014, the highest reading since Q3 2013, but still accounting for only 10.6% of total patents filed in Ireland.

Chart to illustrate:

3/4/3014: Tax or Not: Sunday Times, March 9, 2014

This is unedited version of my Sunday Times article from March 9, 2014


Speaking at last week's Fine Gael Ard Fheis, Minister for Finance, Michael Noonan, T.D. noted that "As a Government, we know that there are further opportunities in the years ahead for us to build upon the initiatives that have worked.  It is in this vein that …I will consider the introduction of targeted tax reductions that have a demonstrable effect on employment growth."

With these words, Minister Noonan finally set to rest the debates as to the Government intentions with respect to core policies for 2015 and thereafter. Whether you like his prior policies or not, he makes a good point: Ireland needs a tax-focused policy intervention. And we need an intervention that simultaneously addresses the declines in after-tax household incomes endured during the current crisis, and does not trigger rapid wage inflation and jobs destruction that can be associated with centralised wage bargaining. The window for an effective intervention is now, in part because as recent evidence shows, fiscal policy effectiveness is greater at the time of near-zero interest rates. But beyond an intervention, Ireland needs a longer-term reform of taxation system.


In general, any economic policy can be judged on the basis of two core questions. Firstly, does the policy offer the most effective means for achieving the stated objective? Secondly, is the policy feasible in economic and political terms?

Reducing income tax burden for lower and middle class earners yields an affirmative answer to all three of the above questions. No other alternative proposed to-date – a cut in VAT rate, a reduction in property tax burden, or an increase in public spending on core services to alleviate cost pressures on families – fits the bill.


Starting from the top, cutting income-related taxes in the current environment makes perfect sense from the point of view of economics.

The three stumbling blocks on our path to the recovery are anaemic domestic consumption, high burden of household debts, and collapsed domestic investment. All of them are interlinked, and all relate to low after-tax disposable incomes. But the last two further reinforce each other. High levels of household debt currently impede restart of domestic investment by both households and firms. They also act as partial constraints on our banks ability to lend. Meanwhile, low domestic investment implies depressed household incomes and high unemployment. In other words, reducing private debt and simultaneously increasing domestic investment should be a core priority for the Government.

On the other side of the national accounts equation, stimulating private consumption offers a weak alternative to the above measures. Due to high imports content of our average consumption basket most of the discretionary spending by Irish households goes to stimulate foreign exporters into Ireland. And it is this discretionary imports-linked spending, as opposed to consumption of non-discretionary goods and services, that has taken a major hit during the Great Recession. Beyond this, higher domestic consumption will do little to raise our SMEs exporting potential, in contrast with increased investment.

Take a quick look at the top-line figures from the national accounts. Based on data from Q1 1997 through Q3 2013, cumulative decline in personal consumption of goods and services over the current crisis amounts to roughly EUR5 billion, when compared against the already sky-high 2004-2008 trend. For gross fixed capital formation - a proxy for investment and capital spending - the cumulative shortfall is EUR50 billion against the 2000-2004 trend, which excludes peak of the asset bubble period of 2005-2007. Put differently, compared to peak, private consumption was down 12 percent in 2013 (based on Q1-Q3 data), while gross investment was down 65 percent. If in 2013 our personal consumption is likely to have returned to the levels last seen around 2005-2006, our investment will be running closer to the levels last witnessed in 1997-1998.

More significantly, lending to Irish non-financial, non-property SMEs has fallen 6.2 percent year-on-year at the end of 2013, as compared to 5 percent for the same period of 2012, according to the latest data from the Central Bank. Meanwhile, value of retail sales was down only 0.1 percent in 2013, according to CSO. Things are getting worse, not better, in terms of productive investment.

It is, therefore, patently clear that an optimal policy to support domestic growth in the economy should target increases in the disposable income of households and incentivise investment and savings ahead of stimulating consumption. It is also clear that such increases should be distributed across as broad of the segment of working population as possible.

To achieve this, the Government can reduce the burden of personal income taxation.

Alternatively it can attempt to target a reduction in the cost of provision of non-discretionary services, such as childcare, health, basic transport and education. In fact, the main arguments against lower taxes advanced by the Irish Trade Unions and other Social Partners are based on the idea that such costs reduction is possible were the state to invest taxpayers funds in further development of these services as well as provide subsidies to supply them to the broad public.

Alas, in practice, Irish public sector is woefully poor at delivering value-for-money. Since 2007 through 2013, inflation in our health services outpaced the general price increases across the economy by a factor of 5 to 1, in transport sector by 3 to 1 and in our education by 12 to 1. Pumping more money into provision of public services might be a good idea when it comes to achieving some social objectives. It is certainly a great idea if we want to stimulate public sector employment and pay, as well as returns to various consultancies and state advisers. But it is not a good policy for helping households to pay down their debts, increase their savings, investment and/or consumption.


Which brings us to the questions of economic and political feasibility of tax reforms.

This week, the Finance Minister confirmed that he will "try to begin the process of making the income tax code more jobs friendly" starting with Budget 2015. Most likely, the next Budget will consider moving the threshold for application of the upper marginal tax rate, currently set at EUR32,800. Minister Noonan described this threshold as being "totally out of line with the practice effectively all over the world, but particularly in Europe." And he's got the point. Across a sample of twenty-one advanced economies, including Ireland, the average effective upper marginal tax rate, inclusive of core social security taxes, currently stands at around 44.4 percent. In Ireland, according to KPMG, the comparable upper marginal tax rate is 48 percent. But an average income threshold at which the upper marginal tax rate kicks in is EUR136,691 in the advanced economies, or more than four times higher than in Ireland.

Widening the band at which the upper marginal tax rate applies to double the current Irish average earnings will mean raising the threshold to EUR71,500 per person per annum. This should be our policy target over the long-term, through 2019-2020.

However, given current income tax revenues dynamics delivering this target today will trigger significant fall-offs in income tax revenues. Data through February 2014, admittedly a very early indicator, shows effectively flat income tax receipts, despite large increases in employment in recent months. In other words, brining our upper rate threshold closer to being in line with the advanced economies average is, for now, a non-starter from fiscal sustainability point of view.

But gradually, over 2015-2016, increasing the 20% tax rate band to around EUR38,000-40,000 should be fiscally feasible, assuming the economy continues to improve as currently projected. This will leave those at or below the average earnings outside the upper marginal tax rate. But it will also provide relief to all those earning above average wages. In other words, widening the lower rate band will generate a broadly-based measure, with likely support amongst the voters.

At the same time, it will also yield significant gains in economic stimulus terms. At the lower end of the targeted band, such a measure would be financially equivalent to a tax rebate of around double the average residential property tax bill.

More importantly, widening the lower tax band will provide for an effective stimulus to the economy compared to all of the above measures. The reason for this is that unlike property tax and VAT, income taxes create economic disincentives to supplying more work effort in the market place. This effect is most pronounced for second earners, self-employed, sole traders and small business owners – all of whom represent core pool of potential entrepreneurs and future employers.

In addition, reducing income taxes, as opposed to consumption and property taxes provides both financial and behavioural support for investment, and savings for ordinary families. A number of studies of consumer behaviour show that savings achieved from the reductions in consumption taxes are commonly rolled up into higher consumption. On the other hand, higher after-tax labour incomes are associated with greater savings, investment and/or faster debt pay-downs.


Beyond widening the standard rate band, the Government can do little at the moment to stimulate disposable income of the households. Yet, in the longer term, we face the need for a more comprehensive and deeper reform of our tax system. Critical objective of such reform is to achieve a new system for funding the state that relies less on income tax and more on direct user-fees charges for goods and services supplied to consumers, plus taxes on less productive forms of capital, such as land, property and speculative assets. Changes in the underlying drivers for growth in the Irish economy will also necessitate tightening of corporate and income tax loopholes. This should lead to increased reliance by the state on corporate tax revenues, while freeing some room for the reduction in tax rates. In targeting these, the Government should focus on the upper marginal tax rate itself.

Designed with care and delivered with caution, such reforms can put Irish economy on the path of higher growth well anchored in the underlying fundamentals of our society: indigenous entrepreneurship, domestic investment and skills-rich workforce.

Box-out:

This week, the EU Commission published its 2014 Innovation Union Scorecard showing comparative assessment of the research and innovation performance across the EU. The good news is that Irish rankings in the area of innovation have improved from 10th to 9th over the last twelve months - not a mean task given our tight economic conditions and scarcity of funds across the economy. The bad news is that we are still ranked as 'innovation follower' and that our performance is still weak when it comes to developing a thriving innovation culture in the SME sector. As experience from the UK shows, just a couple of simple changes to Ireland's tax codes can help us enhance the incentives for SMEs to develop a more active innovation and research culture. We need to reform our employee share ownership structures to make it easier for smaller companies and entrepreneurs to attract key research personnel and promote innovation within enterprise. For example, in Ireland, employees securing an equity stake in the business employing them currently face an immediate tax liability, irrespective of the fact that they receive zero financial gain from the shares until these as sold. This applies also to smaller start-up ventures, particularly the Universities-based research labs. Thus, a researcher working in Ireland's high potential start-up or a research lab can face a tax liability on owning the right to a yet-to-be-completed research they are carrying out. This is not the case across the Irish Sea and in the Northern Ireland. In 2012-2013, the UK Government adopted 28 new policies aimed at promoting various forms of Employee Financial Involvement (EFI) in the companies that employ them. The UK has allocated £50 million through 2016 to promote public awareness of the EFI schemes and is actively working on reducing the administrative burden for companies and employees relating to EFI. It is a high time we in Ireland have followed our neighbours lead, lest we are content with remaining an 'innovation follower' in the EU for years to come.

21/6/2012: FDI attractiveness survey 2012

A very insightful, albeit subject to survey data/methods caveats, report from Ernst&Young on 2011 FDI and attractiveness of Europe (including Ireland) to FDI is just out. Link to downloadable report here.

Some (mostly Ireland-centric) highlights:

The good news is - Ireland is in top 10 in the 9th position - same as in 2010. The bad news - 2011 saw a decline in FDI into Ireland (kind of undercutting the Government claims). Now, keep in mind - these stats are based on number of deals, not size of deals, and these cover only Europe.

Here's what Ernst&Young survey had to say about Ireland:
"Securing 106 new FDI projects in 2011, Ireland retained its ninth place in the ranking of European FDI destinations. US investors provided nearly two-third of the projects. During the past three years Ireland’s competitiveness has improved significantly, with a striking reduction in business costs, including those for payroll, energy, office rents and services. A corporation tax rate of 12.5%, one of the lowest in the world, adds to Ireland’s attractions. In addition, Ireland enjoys good access to the rest of Europe and the Middle East and Africa. The country is also emerging as a preferred onshore destination for software firms seeking to establish regional or global headquarters. During the year, companies including Oracle Corp, EasyLink Services and McAfee Inc established or expanded their European headquarters in Ireland. The country also drew more FDI projects from pharmaceutical companies including Eli Lilly, Sanofi-Aventis SA, Pfizer Inc. and Merck & Co Inc."

Ireland didn't make the list of most attractive countries for FDI in the next 3 years

Nor did Dublin make the list for innovation top locations relating to ICT services (our core competency area), suggesting that ICT FDI into Ireland might be more focused on delivery to European markets, rather than innovation:

Interestingly, when asked what Europe can do to improve its innovation capacity, the responses were:

Needless to say, we are not doing much in Ireland to get priority 1, we claim to have good priority 2, but are hardly putting any policies in place to improve that, we have much of tax incentives already in place, but they are patently not working... as per rest... well, same story, really.

13/5/2012: Sunday Times 06/05/2012: Irish labour costs competitiveness

This is my Sunday Times column from May 6, 2012 (last week), unedited version.

Latest research from ESRI shows that, contrary to the prevalent opinion in the media and official circles labour earnings in Ireland have been rising, not falling, during the early years of the crisis. This trend, on the surface, appears to contradict claims of wages moderation in the private sector, the very same claims that have been repeatedly used to argue that structural reforms and changes in Ireland during the crisis have seen a dramatic return of productivity growth.

The ESRI research, carried out by Adele Bergin, Elish Kelly and Seamus McGuinness used data from the National Employment Surveys on the changes in earnings and labour costs between 2006 and 2009. Per authors, “despite an unprecedented fall in output and rise in unemployment, both average earnings and average labour costs increased marginally over the period.”

Surprising for many outside the economics profession, these findings actually confirm what we know from Labour Economics 101.

Firstly, wages and earning are sticky when it comes to downward adjustment. In other words, while wages inflation can be rampant, wages deflation is a slow and economically painful process. This is precisely why currency devaluations are always preferred to cost deflation (or internal devaluations) as the means for correcting recessionary and structural imbalances.

Secondly, wages deflation  is even slower in the economies where collective bargaining is stronger. Ireland is a strong candidate for this with its Social Partnership and tenure-linked pay structures.

Thirdly, average earnings movements reflect not only changes in wages, but also changes in the composition of the national and sectoral employment. More specifically, as the ESRI study concludes, the core drivers of rising earnings during 2006-2009 period were “increases in both the share of and returns to graduate employment and a rising return to large firm employment”. Of course, both of these factors are correlated with the destruction of lower-skilled and less education-intensive construction and domestic services jobs.

Lastly, increases in part-time employment also drove up average earnings. In fact, the latest figures from the Eurostat show that a total of 7.4% of our currently employed workers are classified as part-time employees willing to work longer hours, but unable to secure such employment. This is the highest proportion in the entire EU27, and well above the 3.9% reading for Greece.

Overall, ESRI researchers concluded that “a good deal of the downward wage rigidity observed within Irish private sector employment since the onset of the recession has largely been driven by factors consistent with continued productivity growth.”

In my opinion, this is not a foregone conclusion. Irish labor productivity may have risen during the period of the crisis, but much of that increase is probably accounted for by the very same four forces that drove increases in earnings. Higher proportion of jobs in the economy within the MNCs-dominated exporting sectors, higher survival rate for jobs requiring higher skills, and the nature of the early stages of public sector employment cuts most likely simultaneously explain changes in both earnings and productivity.

The latter aspect is worth explaining. In the early part of the crisis, all public sector employment reductions took place out of cuts to part-time and contract positions, thus most heavily impacting lower earning younger workers. This would simultaneously increase the proportion of higher paid public employees and the average productivity in the sector. Post-2009, cost reductions have been running via early retirement schemes, but these are not reflected in the 2009 data.

In other words, on the surface, it might appear that Irish labour productivity has grown over time, but in reality, it is the reduction in less productive workers’ employment that has been driving these ‘improvements’. Incidentally, this story, not the ESRI conclusion, is consistent with the situation where domestic economic activity has contracted more than domestic employment.

In brief, our ‘productivity gains’ outlined by the ESRI might be a Pyrrhic victory in the Irish economy’s war for internal devaluation.

And the said victories continued since 2009 – the period not covered in the ESRI study.

Since January 2010, earnings have been falling in Ireland as jobs contraction became less pronounced and as public sector entered the stage of early retirement exits. Irish average hourly labour costs peaked at €28.0 per hour in 2009, 5.7% above the Eurozone average. In 2011, however, the average hourly labour cost in Ireland stood at €27.4 per hour, 0.7% below Eurozone average. If in 2009 Ireland had the eighth highest average hourly cost of labour in EU27, by 2011 we were 11^th most expensive labour market.

According to the Eurostat, across the Irish economy, labour costs rose 7.7% in 2007-2009 period followed by a drop of 1.6% in 2010-2011. However, over the period of the entire crisis, the labour costs are still up 5.2%. The only good news here is that our euro area competitors have all posted higher labour costs inflation. The same pattern is repeated in Industry, Services and across the Public Sectors. Only ICT and Financial Services broke this pattern, driven by fixed wages in the state-owned domestic banking, robust demand for IFSC and ICT specialists. In Professional, Scientific and Technical Activities, earnings rose 6.3% between 2007 and 2011, with wages moderation kicking in only from 2010 with a relatively strong decline of 4.8%. Still, this is just half the rate claimed in the official promotional brochures extolling the virtues of decreased labour costs in this area in Ireland.

With relative stabilization of unemployment and longer duration of joblessness, our average earnings are now set to decline over time as younger educated workers come into the workforce to replace retiring older workers. In the mean time, our productivity metrics will continue to improve in specific MNCs-dominated exporting-heavy sub-sectors. Competitiveness will improve, but not because real productivity will expand. Instead, continued re-orientation of economy toward MNCs will drive headline numbers as we become more and more a tax haven, rather than indigenous entrepreneurship engine.

These accounting-styled gains in productivity and cost competitiveness are likely to coincide with stagnation of Ireland’s GNP. In the period since 2007, Irish after-tax earnings have actually suffered significant deterioration compared to our counterparts in Europe. This deterioration is strongly pronounced for demographically most productive part of our workforce – those in the 25-45 years of age.

Eurostat data shows that in 2007-2011, after-tax earnings in Ireland have increased only for single persons with no children earning 50% of the average wage (a rise of 2.3%) and households with two parents and two children on 100% of the average wage income and sole earner (up 1.8%). The smallest declines in after-tax earnings occurred for the category of single person households with no children earning 100% of the average wage (down 0.8%), families with two earners and no children bringing in 200% of the average wage in combined earnings (down 0.8%), and families with similar income (down 0.6%). At the same time, the largest declines in after-tax earnings were recorded for single persons and families with no children and earnings of 167% of the average wage (declines in the range of 2.3% and 3.7%). Above-average after-tax earnings drops were recorded for all other types of households, including families with children on combined earnings in excess of 133% of the average wage. In other words – younger households and households with two earners have been the hardest hit by the recent trends.

With decline in net after-tax earnings, Irish economy is now facing a number of pressures. Costs of living, commuting and housing are likely to continue rising in months and years ahead, driven by the state desire to extract more in indirect taxation and the market structure that is largely captured by the less competitive state enterprises and defunct banks. Direct tax burden will also continue to rise, while pre-tax earnings will fall. These pressures will imply further reductions in consumer spending and domestic savings. The latter means, among other things, that we will see renewed pressure on banks (as part of our savings reflects repayment of household debts) and on domestic investment.

CHARTS: 

Box-out:

The latest Community Innovation Survey for Ireland for the period of 2008-2010 has been released by the CSO, detailing some very interesting trends in overall innovation activity in Irish economy. Headline figure shows that 28% of enterprises in the industrial and selected services sectors had product innovations in 2008-2010, with 33% of enterprises engaged in process innovations. However, only 18% of enterprises were engaged in both process and product innovations. Not surprisingly, foreign-owned enterprises led Irish-owned enterprises in terms of product innovation 38% to 25%, in process innovation 40% to 30%, and in dual product and process innovation 25 to 16%. Irish-owned enterprises derived slightly more of their total turnover from adopting innovations new to the firm, while foreign-owned enterprises led strongly (more than 2.5 times) in terms of new to market innovations. This suggests that Irish enterprises strength remained in adopting new innovations developed outside, while foreign-owned enterprises are strong leaders in creating new products, services and processes for the market. Not surprisingly, of €2.5 billion spent on innovation in 2010, just 49% went to finance in-house R&D. The most innovation-intensive sector of the MNCs-dominated economy was, not surprisingly Manufacture of petroleum, chemical, pharmaceutical, rubber and plastic products (72.5% of enterprises with technological innovation activities), while the most intensive traditional sector was Manufacture of beverages and tobacco products (91.7%). Did someone mention booze and pills sciences?

Economics 18/10/2009: Soros-Nama, R&D spending, Pat McArdle v Morgan Kelly

Update 1:
Karl Whelan is very good on McArdleism - read here.
As does Stephen Kinsella (first hand account) - here.

Update 2: What Apple's latest numbers tell us about R&D investment

Apparently, our Montrose journos have no respect for both - the basic right of freedom of speech and expression and the basic premise that true patriotism is about telling the truth, not about donning 'green jerseys'... This is why I stopped watching majority of RTE programmes long ago - at least BBC (for all its biases) has balls to support freedoms of speech and expression.


Couple of housekeeping items... one on Nama and another one on Knowledge Economy, plus Pat McArdle on Morgan Kelly and more...


Reading through September 2009 interview George Soros gave to Bloomberg Markets magazine, I can across the following quote from the legendary speculator:
Q: "Is this economic contraction something new or something we've seen before?"
GS: "No, you haven't seen it before. Historically, you have the 1930's, the Depression, but since then, whenever you had a financial crisis, the authorities always took care of it and stimulated the economy, extended credit and got it going again. And that just made the bubble grow bigger. (Emphasis is mine) This time it is the end of an era and this is different from any of the financial crises that you have experienced in your lifetime."

The interviewer did not pursue any of the points made by Soros above in any detail. He moved on to the next question. This is a sad opportunity missed because what Soros was saying here (or hinting at) is of potentially great significance. If the current crisis is an end of an era of credit-fulled bubble then:

• Restarting a new credit cycle is not a solution to the systemic problem, but another attempt to temporarily re-inflate the bubble. In terms of Nama, why are we assuming that the Irish economy needs another credit expansion, especially the one that is (hoped) to be restarted on the back of purely domestic credit injection? Ireland is a tiny drop in the ocean of global finance and an idea that we can, at the expense of our own taxpayers, relaunch a credit mechanism in this country's banking sector is patently absurd. It is equivalent to pouring a cup of water into a desert of quick sands in hope that life will return...
• Even more fundamentally, if this is an end of an era of credit expansion-driven growth, then what will be the new paradigms for future growth? A topic worth exploring before we commit to a futile effort of reigniting lending in one of the world's most indebted economy.
• Lastly, if credit-financed growth is the thing of the past, then will new growth path be steep enough to achieve returns on peak-of-valuations loans Nama is taking in? Most likely, the answer will be no.
  

The next question asked of Soros is even more significant:
Q: "Are we trying to have a pain-free crisis? Is a consolidation needed?"
GS: "I'm afraid that is the case. We should have taken the pain and recapitalized the banks. Instead of that, we kept them alive and gave them hope that they can rebuild their balance sheets, and that is going to drag and weigh on the economy for a long time to come. We suffer from an inability to face an unpleasant reality. We expect our politicians to effectively deceive us, to tell us things are better than they are. That is our weakness."

A brilliant statement, reflective much more of the Irish realities than of those of the US.

• Nama is par excellence a 'repairing of balancesheets' exercise, not a recapitalization one (hence the Government is now committed to post-Nama recapitalization). My article in the current issue of Business & Finance magazine clearly shows that a recapitalization via direct purchase of equity is more cost efficient than Nama. It will also address the problem of capital adequacy, while leaving the banks to manage the loans. Soros is talking about this type of a solution. And yet, official Ireland remains indifferent to any proposals other than Nama.
• We really do, culturally, ethically and economic policy-wise look into Government's mouth in hope of hearing them utter something re-affirming, something positive. We take distorted estimates for hope, half-truths for optimism and huge tax bills for 'necessary corrections'. If Nama will drag this economy down for many years to come, our innate desire to rely on the state for 'tough solutions' while we avoid the truth is going to hold us in this crisis for decades.
  

Oh, and there is an interesting note from Crimson Observer blog (here) - it looks like some old bubble-time hawks are jostling to position themselves as the buyers of distressed properties in Ireland as Nama bites into the market... Interesting. But taking this further - will Nama trigger re-transfer of defaulted properties back to the, pretty much the same, hands of old developers at a knock-down price? Possibly...


Short note from the land of high R&D spending (sorry 'investment'):

"The 908 million euro ($1.3 billion) goodwill write-down on Nokia Siemens Networks, ...certainly contributed to the unexpected 559 million euro ($833.9 million) loss reported by Nokia in the third quarter. However, Nokia had forewarned that it would be writing down the value of the business after successive quarterly losses. A more worrisome and unexpected trend, however, is the lackluster demand for Nokia's smart phones, essentially phones that double as mini computers such as the N97 and the E60. The company's share of that market globally fell to 35% in the quarter ending in September, from 41%."

So (quote above is from Forbes magazine) Nokia (aka Finnish economy) is suffering from:

• Lagging position in smart phones (despite Finland having higher civilian R&D spending as a share of GDP than it's closest rival in smart phones market - the US);
• Lagging strategy to the market - Nokia unveiled details of its forthcoming N900 phone in the middle of the third quarter, well after new launches by Google and Apple;
• heavy competition in China and India from low-cost producers (despite Nokia's vast outsourcing and off-shore production network, partially financed by Finnish taxpayers).

Run through the above 3 points and you can see that R&D spending on labs and technicians has nothing to do with Nokia's woes. Simple business management, marketing, strategy and business processes flexibility are behind it losing ground to its rivals.

In contrast to Nokia, Apple just posted (Monday) a 46% increase in its fiscal Q4 earnings and higher revenue than a year ago led by better-than-expected sales of iPhones, Mac computers and iPods (here). You can read about Apple strategy in terms of introducing new products at higher frequency than its rivals and launching upgraded software to coincide with new products offerings in the above-linked article. But what actually put Apple back into the global competitiveness game was not just product innovation - it was i-Tunes concept for selling music and then Apple Store concept for selling hardware, followed by, yes - i-Phone APS online 'store'. It is retailing that reinforced product innovation for them - something that Nokia with its government-supported R&D spending programmes can't replicate to date.

Still want to chase Finns in putting more R&D spending onto the Exchequer books?..


The news that Pat McArdle (reported here) had a total meltdown in his challenge of Prof Morgan Kelly did surprise me. I have deep respect for Pat's work back in the Ulster Bank - he was one of the most knowledgeable bank economists of recent times and I always valued his research notes for an inimitable ability to link intuition and data. Ditto for Prof Kelly.

Hence, I was shocked to learn that Pat McArdle questioned Morgan's right to express his views. I certainly hope that Pat will publicly apologise to Morgan for this outburst. And I certainly hope that Kenmare organizers would have guts to openly defend Morgan's liberty to say what he wants on the subject of economics and economic policy when he wants to say it.

One would expect censorship to be despised and rejected in academic setting and amongst social scientists. Alas, I know first hand that this is where it is practised. For example, a birdie chirped to me recently that one department of economics in Ireland has recently explicitly banned its junior members (senior faculty of course said 'Non' to the ban) from speaking to the press or expressing their opinions in public on the matters of economic policy unless they obtain a prior consent of the Department Head. How's that for 'democratic' and 'socially active or relevant' academia? Standard job descriptions for academic posts in this country state that one of the parts of our work involves service to a broader community outside the halls of academic institution.

This is precisely why I hope my colleagues who attended Kenmare and were first hand witnesses to Pat's attack on Morgan (alongside Kenmare organizers) issue a clear statement as to the value of the freedom of speech and expression and the value of freedom of thought.

For now, I am saddened by the fact that an economist for whom I have nothing but respect had joined a pack pursuit of independent thought...

Economics 16/09/2009: IDA's latest news... breaking

I will blog on Nama latest figures tomorrow afternoon, so stay tuned, but for now - a piece of better news:

IDA will be launching a new campaign promoting Ireland as investment destination in the USofA. The campaign was prelaunched tonight for bloggers in advance of the official launch. It is impressive in scope (all top notch business media on top of the reliables – Airport ads etc – plus a bit more serious effort to build online presence) and relatively mild in message (more below). So mild, it seems to be slightly underwhelming.

Fair play to Barry O’Leary (Chief IDAologist) and his crew and campaign designers (McConnells) for actually braving the small crowd of usually unruly and unpredictable, often cranky and always suspicious bloggers. Trevor Holmes – IDA’s chief communicatologist, aka PR man – was actually very good in answering pointed stuff and taking a bit of a role of really giving us (the bloggers) some of our own medicine.

So the launch itself was a brave change of heart from the usually rather closed organization like IDA.

Let’s get to the substance.

Corporate brand advertising that is people-centric can be corny. Country brand advertising based on ‘Invest not in dollars, but people’ stuff is a bit corny and old. IDA used to do the same back in the 1970s and 80s, so what’s the BIG IDEA this time around?

Ok, on their web banners they have Facebook chieftain talking about what the company found in Ireland. Guess what – it is European workforce (same is the 1980s ads) and it is not Irish (novelty factor on the 1980s), but the one speaking 48 languages with native skill. You might as well be in London for that.

Microsoft’s Head is talking about how IDA is number one conduit for companies into Irish Government. I though that sort of ‘facilitation’ – important as it is to the companies – is not exactly something we want to highlight as a major selling point, at least not publicly in the airports. Children might conjure the imagery of Bertie Ahearne ‘facilitation’ at a football game somewhere in the UK, or our regulatory authorities engaging in banking sector ‘facilitations’ signing off on intra-banks deposits flows of slightly unusual variety. All fresh in the media minds internationally.

Funnily, when I asked the guys if they can ‘facilitate’ a financial funds management company with speeding up regulatory clearance to trade in Ireland, they immediately stressed that Ireland is not that sort of a country… Innocent me, I couldn’t see much wrong with helping companies to file papers at the FR office, especially when the same FR office got so facilitative of the banks in the recent past… Oh, but IDA can help with preparing documents and reasoning to be brought to the FR “to make the case for…” Hmmmm. Ok.

“Talents, scope and depth, languages spoken, diversity… and foremost Irishness…” are the themes. Judge for yourselves if this really confuses Ireland with a D2 - D4 (Googleland, language schools and TCD/UCD) cluster.

‘Natural creativity and curiosity of Irish’ themes. I know, it sounds bad. But do trust me, the ads are well designed and speak modern, clear and crisp language as are online materials - McConnells delivered again. IDA opened up their closed doors a bit here too with online campaign aiming to be more interactive with target audiences. Cuddos to McConnells Digital on that one - hard client to get to smile, but smiling is what IDA are doing with some parts of the campaign and it is good to see the Big Boys of Ireland Inc getting a little of confidence back. On the net, a good balance of simple messages, simple imagery and compelling arguments.

But there are few things that troubled me and some other bloggers.

1. Are these ads truthful: IDA referred in presentation to IMI research that allegedly proves these directly. I am not sure – would have to see this piece of research to believe it. But the campaign itself does not mention any research. So you are invited to find out for yourself and herein opens a world of our low achievement in the areas of science, relatively average achievements in education and an abysmal record on early and continued education.
2. The ads mention Ireland’s promise in Green energy (not as a distant future, but as current reality). In a country with ESB plants belching smokestacks and heavy reliance on oil to generate one of the most expensive power supplies in Europe, this sounds slightly funny. To be truthful, we had Airtricity – an international success story, but it barely had any significant investments in Ireland proper, preferring to do business in… you’ve guessed it – UsofA. And UK. So who’s ‘greener’?
3. On the same day of the IDA blogger launch, I was speaking to the National Advisory Science Council about my view as to why our R&D and science policies (core innovation inputs) might be in trouble. Innovation Ireland, my eye.
4. Funnily, me recalls seeing in Fortune and Forbes ads for Azerbaijan and Kazakhstan as places where you too can invest not in dollars but in people and innovation... not exactly in same words, but the same message.

While I am on the topic of press, IDA will follow up these adverts with a full frontal media assault taking ‘articles’ in the likes of WSJ and other business media and getting Brian Lenihan (who can do some good) and Barry O’Leary (who really does know his stuff). But also Mary Coughlan (I know, don’t start, please... oh, the hell - as Donald Rumsfeld remarked once "As you know, you go to war with the army you have, not the army you might want or wish to have") on the international media ‘telling the Irish side of the story’. I am not sure what it will look like? Advertorials, interviews, hired hacks, ads, talking sale pitches from politicos… It makes me feel like being made a small tangential part of some PR blitzkrieg. Trust, me I am not!

One question I did ask Barry O’Leary was “IDA campaign is going to court Human Capital-intensive businesses for whom the costs of skilled labour and key talent are the main line of spending. Our Government officials will be talking about how we are doing the necessary things to restore economic growth and confidence. Are you concerned that this is the same Government that raised taxes on labour income impacting ‘knowledge’ economy’s future returns to human capital here?” The response I got suggested that yes, the IDA are concerned about the erosion of competitiveness (I presume that does include erosion of our competitiveness in ability to attract highly paid talent). So “tax increases are a concern, but [not too much as IDA prefer for the] …focus to remain on total offering and proposition of Ireland across different value chain segments”.

Is then IDA feeling boxed by the Government perverse policies and are searching to offset the cost of income tax and payroll costs with other concessions? Most likely.

Barry didn't mention if the ‘competitiveness’ concern also covers corporate tax. After all, given the hole Mr Cowen got this country into fiscally, and given that our households are already struggling under the massive burden of Nama and public sector wage bills and welfare rolls, what can be done next to ‘improve’ our fiscal situation other than start dipping into corporate Ireland’s pockets. Indirect taxes will rise for businesses and, quite possibly, there will be a push for higher corporate tax rate too.

A birdie told me that the Government has already discussed (at not a full Cabinet level, though, and I stress that is a tip-off that I am yet to fully confirm) a chance of raising a special corporate tax surcharge on domestic firms, but that they were told that this won’t fly with EU. Don’t worry – most likely, they’ll try again.

Barry was talking some good facts, though, and made a serious pitch as to why we need to get Ireland Inc back into raising the FDI game – something that has been hard to get (although IDA did achieve good progress this year against all odds) in the first 6-8 months of this year. I agree with him fully – and I must add that IDA and EI are about the only two agencies in town that are still doing their jobs (I am sure improvements can be made in both, but hey, in the age of FAS, Forfas, HSE, and the rest of public sector, at least IDA and EI give us some return for money).

When it comes to target businesses, again, there was no BIG NEW THEME – IDA is going after reliable favorites: life sciences (pharma, biopharma and medical devices), ICT&IT, global services (SCM, technical support, financial & shared services). Not a hell of a lot of ‘innovation’ stuff? True, but they are looking at the “Innovation sector: IT&ICT primarily, Hewlet Packard, Intel, IBM, etc; life sciences area (pharma, biopharm, medical devices), international financial services, globally traded business services – digital media, etc and old engineering portfolio.”

So everything flies. A true picture of diversity? I’ve asked the guys: “Loads of smaller companies would probably like to enter European markets through Ireland. What are you doing for them?” It is a loaded question and Trevor Holmes was good answering it – to the point: “can help with limited pilot, test beds”. Better than nothing, but, honestly, not much. The mandate, you see, is still about bringing Big Sharks in, not the smaller Barracudas.

There was a hint of something yet to come – Trevor mentioned that the IDA are working on several new ideas as to how they can facilitate incubation of smaller promising start ups willing to settle in Ireland. That’s the stuff I would love to find out more about. Some years ago I mentioned the idea of incubator for Ireland-bound startups in financial services in a conversation to Barry O’Leary. May be finally the idea has sunk in? Alas, no details were given.

Per Barry O’Leary: “Competition globally for FDI – OECD says it is down globally 30% in 2009, and more competitors in the market – margin squeeze on both ends.” Fair point and the timing of this campaign is spot on too – the US market is about to go into new investment cycle, and we should be ahead of the curve (although the IDA team failed to actually identify this as an opportunity explicitly when they were probed by the bloggers). “We are competitive in combined development and manufacturing, but not in manufacturing alone”. Another good point, and backed by the evidence on what IDA has been bringing into the country over the last year.

Final point – per Barry O’Leary – is that “Strategic review of IDA is 6-8 weeks before conclusion looking at changes and adaptations to such new product offerings in Ireland as smaller digital media companies…”

Looking forward to hearing more on that one.

Economics 2/06/2009: Innovation debate

My article in the Sunday Times last weekend has triggered some responses. The article is reproduced below.

Here is a link to at least one good reply, from DCU's President, Ferdinand von Prondzynski. In spirit of debate, I decided to address couple of points he raises in the post:

Ferdinand is right that I am arguing 'against' the current approach of promoting, disproportionately, the idea of lab-based innovation. But I think he is wrong in downplaying what I suggest as the way forward.

I am talking about the need to focus more on where the actual returns to innovation are. From business point of view, these returns are in 'soft' innovation - process innovation, managerial improvements, logistics, communications, etc. These have been neglected in academia and SFI has virtually no presence in these areas. Interstingly, Ferdinand actually appears to present these areas as being somewhat below the 'real' innovation, 'understood as investment in high value science and technology'.

I mention a Wal-Mart effect and the value-added accruing to marketing and sales as being more important than producing new patents and scientific papers. I am yet to see an argument that the former yields lower returns to the society and economy than the latter.

Ireland is a small player and holds little promise to deliver hard innovation on global scale. But it does offer a strong potential for delivering high value-added sales, international links etc. It cannot be a unique supplier of a significant number of competitively innovative products on a global scale, but it can be a platform for domiciling innovation of others. For that we have location, links to the EU and the US, and we have talent.

Yet, how many professors of biotech or computer sciences do we have? Dozens. How many professors of finance do we have? A handful. Our system of research and teaching assumes that there is no need for raising investment in innovation or in higher value-added activities because we became fully reliant on the State to provide such financing. We have virtually no indigenous R&D investment, with most of private sector R&D expenditure delivered by the MNCs.

Ferdinand might want to ask the following questions:

1. Can we build a thriving economy without any domestic biotech graduates? To me the answer is yes. Can we train a single biotech graduate without a system of funcitioning finance? To me the answer is no.
2. If you have limited resources to invest in two activities: activity A (lab coats) yielding X% return per annum, activity B (finance) yielding 2X% pa, with everything else being equal, which one would you choose? To me the answer is B. But hold on, B also offers better jobs security for people than A, more diversified markets on which the service can be sold, it is an activity that has remained with us for centuries, so it does not become obsolete. And it can be built in 5-10 years, unlike lab coats that might become outdated by the time we actually have them exiting out Universities.
   

So we have a chain of national economic development that should be going from: build a base for finance and business services first, then indulge in a luxury of producing lab coats. Not the other way around.

I am, of course, exaggerating somewhat, for lab coats are also important. SFI and our Government have made a choice - lab coats and nothing more. I am merely suggesting that we need more!

Are we a country that hosts MNCs and provides them with support labour, or are we a platform from which MNCs actually add value? If we are the former, we need to produce more hard science PhDs. If we are the latter, we need more specialists in marketing, sales, finance, etc. Value-added by the former - not much, once you adjust for the risk of failure and the scale of our R&D sector. Value-added by the latter - well, look at Switzerland, for example, or Luxemburg, or Austria. Hard R&D-intensive IT and Pharma sectors there account for at most 10% of GNP, finance and B2B services account for 30-50%.

Can we be like Switzerland? Yes, if we focus instead on business services, e.g financial services, and import talent for labs-based employment, we will still be able to produce innovative goods and services, but we are no longer running the risk of ending up with the indigenous specialists who are at risk of becoming redundant the minute technology trends shift. Ferdinand might point to the fact that Switzerland trains many hard science PhDs, but hey - they started doing so after centuries of investing in finance and business services.

Finally, there is another argument in favour of abandoning our senile concentration of 'innovation' on ICT and bio: it is a basic 'diversification of your investment' argument... lab-coats simply do not get this.



Sunday Times, May 31, 2009 (un-edited version)

Back in December 2008, Irish Government unveiled its response both to the current crisis and the longer-term growth challenges. The plan, bearing a lofty title Building Ireland's Smart Economy was an amalgamation of tired clichés. But it contained an even less palatable revelation: our Government has not a faintest idea as to where economic growth comes from. This plan – never implemented – would be the old news, if not for the insistence by our leaders that it remains the cornerstone of economic policy.

Economic growth happens when entrepreneurs and investors find new means to extract more value out of existent resources. This is not the same as our Government’s concept of the smart economy.

Instead, Government ideas are closer to Mao Tse Tung’s Great Leap Forward than to the intensive growth models. Mao believed, literally, that shoving more production inputs into economy was growth. Brian Cowen and his Cabinet believe that getting more PhDs and public capital into sciences-dominated sectors generates growth. Net result will be a waste of economic resources for several reasons.

Sustainable growth requires very little in terms of armies of science bureaucrats, people in lab coats and science campuses, and much more of the incentives for business competitiveness and productivity. Over the last 20 years, worldwide improvements in logistics and retailing (known collectively as the Wal-Mart Effect) have yielded several times greater contribution to economic growth than the so-called innovative sectors like bio-tech, nanoscience, clean energy technologies and other lab-based activities combined.

Ireland has missed the Wal-Mart Effect because of the Government’s economic illiteracy that wastes billions protecting inefficient domestic services from competition. Ditto for other crucially important business infrastructure: legal, accountancy, medical, media, energy, utilities and so on. We are languishing at the bottom of the world league in communications services (ranked 23^rd in 2008-2009 Global Information Technology Report) just as the Government policy papers and programmes promising to make Ireland the innovation wonderland by 2013 abound.

Studies in pharmaceutical economics show that the risk-adjusted returns to scientific R&D leading to the development of a blockbuster drug are only half as large as returns to marketing, sales and distribution. When value at risk assessment of pharmaceutical investment accounts for large research pipelines economic returns to companies like Elan (a tiny minnows in the world of global pharma) can be negative.

Our focus on science-based R&D is hopelessly out of synch with international trends. Five years ago, biotech, customiseable software, nanotechnologies, alternative fuels, energy storage and the rest of the fancy scientific stuff were the domain of smaller companies. Today, the big boys of global business – the likes of Pfizer and IBM – are firmly in the field and next to them indigenous Irish enterprises have little chance of succeeding in either attracting capital, or hiring the requisite talent, or capturing markets for their products.

Our real (as opposed to lofty policy-based) metrics reflect this. Last month Science Foundation Ireland claimed that it expects 30 local R&D-based start-ups and 40 revenue generating technology licenses to emerge over the next 5 years. This implies that billions spent on the ‘knowledge’ economy will be adding some 60-100 new jobs or less than half a license per Irish academic institution per annum. In almost 7 years of its existence, SFI supported creation on only 250 patents (1.7 per academic institution annually). Virtually none have any commercial value to date.

All along, our state policies have ignored more productive avenues for growth: international finance, business services and market access platforms. While successful in delivering serious presence of Dublin for international back-office and domiciling operations, to-date we have failed to foster the emergence of Irish front-office activities. Yet, if back-office accounts for roughly 5-10% of the total value added in financial services, front-office (you’ve guessed it: sales, marketing, research and management) account for the rest.

Although employee value-added in Irish internationally traded financial services is some 70% greater than in the IT sector, no innovation policy recognises this. International financial services can be even more R&D and knowledge-intensive than the lab-coat sectors. Strangely, you can get tax breaks for developing new financial software – with a risk-adjusted return of ca10% per annum, but you will be paying exorbitant transactions and income taxes on research- and knowledge-reliant financial management activities.

There are even more bizarre twists in Irish policy. Irish Governments – from time immemorial – have preferred simplistic numerical targets to quality analysis and cost-benefit assessment. Thus, we now have a patently absurd goal of doubling the numbers of PhDs in Ireland by 2013 without any regard to the quality of these researchers. We have no stated goals as to the international rankings we would like to achieve for our numerous third level institutions generously financed by taxpayers. Only four out of our 7 universities and 14 ITs (TCD, UCD, UCC and UCG) have serious chances to either retain their position in the top 200 rankings or reach such position in the foreseeable future. Not a single Government department or public body is expressing any concern about this lack of competitiveness.

[Note: I do recognize (hat tip to Ferdinand von Prondzynski) that by latest rankings, DCU is actually ahead of UCG, so the list should have read TCD, UCD, UCC/UCG and DCU, per my belief that UCG can be competitive if and only if it merges with UCC]

Even more disconcerting is the total lack of foresight as to the employment prospects for our new PhDs. In the US some 50-55% of PhDs are employed by taxpayers. In Europe, the number is even larger – around 70%. In Finland – long regarded to be inspiration for Ireland’s knowledge economy – only 15% of PhDs are employed in the private sector. Majority of Irish PhDs go on to take up post-doctoral grants financed by the Government. They are, in effect, employees of the state with no academic positions and little hope of gaining one in the future. How many will find employment commensurable with their stated qualification once their grants run out in 2-3 years time?

Irish policy structures are simply unsuited to the emergence of entrepreneurial and productivity-enhancing culture necessary to sustain real long-term investment in knowledge-intensive enterprises. Most of our civil service is based on anti-entrepreneurial centrally planned system. Majority of our public service employees lack requisite knowledge of the private sector and the comparable aptitude to understand the present economy, let alone to accurately foresee its future needs. This is reflected in education and research policies, economic analysis documentation and in the structure of taxation.

Instead of providing incentives for business-related innovation, our taxation system penalizes investments in human capital with punitive rates of taxation. Returns to investment in property or physical capital in Ireland imply marginal tax rates of 0-25%. The same investment undertaken in education faces a marginal tax rate in excess of 50%. Chart above shows the relative taxation burdens associated with human capital and property between 1998 and today. As Ireland embarked on the path of building ‘knowledge economy’, tax on human capital as a share of overall tax revenue rose from roughly 63% in 2006 to 80% this year.

High income and consumption taxes are directly linked to the fact that three quarters of the EU nationals who obtain higher degrees in the US never return back. Are we setting ourselves up for the future brain drain from Ireland as well?

In years ahead Ireland stands a chance of either becoming a booming 21^st century economy or a laggard to the increasingly geriatric Eurozone. This choice will be based on our ability to deliver real entrepreneurship and skills infrastructure. More than a breeding programme for PhDs, this will require reforming taxation system to incentivise commercially viable knowledge, risk-taking and skills acquisition. It will also require support of a top-to-bottom reshaping and scaling down of our public sector and focusing the state priorities on delivering real improvements in simple things like communications and early education.