1/12/2011: Sunday Times, 27 November 2011

Here is the unedited version of my article in the Sunday Times, November 27, 2011.

Since the collapse of the bubble, Irish perceptions of the residential and commercial property markets have swung from an unquestioning adoration to a passionate rejection.

As the result of the bubble, the overall share of property in average household investment portfolio is likely to decline over time from its Celtic Tiger highs of over 80% to a more reasonable 50-60%, consistent with longer term averages in other advanced economies. But housing will remain a significant part of the household investment for a number of good reasons.

While providing shelter, housing wealth also serves as a long-term savings vehicle and an asset for additional borrowing for shorter-term investments. Security of housing wealth in normal times acts as an asset cushion for family-owned start up businesses and a convenient tool for regular savings. Over the lifetime, as demand for housing grows with family size, we increase our savings, normally just as our life cycle earnings increase. We subsequently can draw down these savings throughout the retirement when income from work drops.

In short, in a normal economy, housing and household investment are naturally linked. In this light, the grave nature of our economic malaise should be apparent to all. Ireland is experiencing a continued and extremely deep balance sheet recession, with twin collapses in property prices and investment that underlie structural demise of our economy.

The latest Residential Property Price Index, released this week, shows that things are only getting worse on the former front. Overall, residential property price index fell to 71.2 in October from 72.8 in September. The latest monthly decline of 2.2% is the sharpest since March 2009 and the third fastest in the history of the index. Relative to peak prices are now down 45.4%. Take a look at two components of household investment portfolios: owner-occupied and buy-to-let properties. For the majority of the middle class families, the former is represented by a family home. The latter, on average, is represented by apartments. Nationwide, per CSO, prices of these assets are respectively down 43.7% and 57.9% relative to the peak.

The impact of these price movements is significant and, contrary to the assertions of the Government and official analysts, real and painful. House price declines imply real capital losses to households and these losses have to be offset, over time, with decreased consumption and falling investment elsewhere. Absent normal loss provisioning available to professional financial sector investors and businesses, households suffer catastrophic collapses on the assets side of their balance sheet, while liabilities (value of mortgages) remain intact. Decades-long underinvestment and low consumption spending await Ireland.

Dynamically, things are not looking any brighter today than a year ago. House prices have fallen 14.9% year on year in October, the worst annual drop since February 2010. Apartments prices are down 19.8% over the last 12 months – the worst annualized performance since April 2010.  Given the price dynamics over the last three years, as well as the current underlying personal income, interest rates and rental yields fundamentals, Irish property prices remain at the levels above the short-term and medium-term equilibrium. This means we can expect another double-digit correction in 2012 followed by shallower declines in 2013.

Not surprisingly, the collapse of the property markets in Ireland is mirrored by an even deeper crash in overall investment activity in the economy. The latest National Accounts data shows that in 2010, gross fixed capital formation in Ireland declined to €19 billion in constant prices. This year, data to-date suggests that capital formation will drop even further, to ca €17 billion or almost 58% below the peak levels. In historical terms, these levels of investment activity are comparable only with 1996-1997 average. If we assume that the excess investments in the property sector were starting to manifest themselves around 2002, to get Irish economy back to pre-boom investment path would require gross fixed capital investment of some €26.9 billion per annum or more than 60% above current levels.

Between 2000 and 2009, Irish economy absorbed some €319 billion in new fixed capital investments. Assuming combined rate of amortization and depreciation of 8% per annum, just to keep that stock of capital in working shape requires €25.5 billion of new investment. This mans that in 3 years since 2009, the Irish economy has lost some €15.5 billion worth of fixed capital to normal wear-and-tear. In short, we are no longer even replacing the capital stock we have, let alone add new productive capacity to this economy.

Looking into sectoral distribution of investment, all sectors of economic activity outside building and construction have seen their capital investment fall by between 18.4% in the case of Fuel and Power Products to 70.4% in the case of Agriculture, Forestry and Fishing sector. So the aforementioned aggregate collapse of investment is replicated across the entire economy.

The dramatic destruction of capital investment in the private sector is not being helped by the fact that Government capital expenditure is also contracting. In 2010, Voted Capital Expenditure by the Irish Government declined to €5.9 billion. This year, based on 10 months through October data, it is on track to fall even further to €4 billion – below the target of €4.35 billion and more than 53% below the peak. In fact, the entire adjustment in public expenditure to-date can be attributed to the capital spending cuts, as current expenditure actually rose over the years of crisis. Since 2008, current expenditure by the state is up 1.9% or €775 million this year, based on the data through October. Thus in 2008, Irish Government spent 17.4% of its total voted expenditure on capital investment. This year the figure is likely to be under 8.8%.

Forthcoming Budget 2012 changes are likely to make matters worse for capital investment. In addition to taking even more cash out of the pockets of those still in employment – thereby reducing further the pool of potential savings – the Government is likely to bring in the first measures of property taxation. This will reinforce households’ expectations that by 2013-2014 Ireland will have a residential property tax that will place disproportional burden on urban dwellers – the very segment of population that tends to invest more intensively over time in property improvements, making the urban stock of housing more economically productive than rural. A tax measure that would be least distorting in terms of incentives to increase productivity of the housing stock – a site-value tax – now appears to be abandoned by the Government, despite previous commitments to introduce it.

Furthermore, we can expect in the next two years abolition of capital tax reliefs, increases in capital tax rates and high likelihood of some sort of wealth taxes – direct levies on capital and/or savings for ordinary households. In the case of the euro area break up, Ireland will also see draconian capital controls.

In short, we are now set to experience an 8-10 years period of direct and accelerating destruction of our capital base. It doesn’t matter which school of economic thought one belongs to, there can be no recovery without capital investment returning back to growth.

Box-out:

In the recent paper titled “The Eurozone Crisis: How Banks and Sovereigns Came to Be Joined at the Hip”, published last month, two IMF researchers identify Europe’s Lehman’s moment in the global financial crisis as the day when the Irish Government nationalized the Anglo Irish Bank. In contrast to the current and previous Governments’ assertions, the IMF study argues that the Anglo was not a systemically important bank worthy of a rescue. As the paper puts it: “The problems [of collapsing financial sector valuations] entered a new phase – becoming a full-blown crisis – with the nationalisation of Anglo Irish in January 2009. The relevance of Anglo is, at first, not obvious, since it was a small bank in a relatively small country. However, …it is possible that the large fiscal costs as a share of Ireland’s GDP associated with this rescue raised serious concerns about fiscal sustainability. Suddenly, the ability of the sovereigns to support the financial sector came into question.” In other words, far from helping to avert or alleviate the crisis, Anglo nationalization caused the crisis to spread. “In retrospect, the nature of the crisis prior to Anglo Irish was simple, being mostly driven by problems in the financial sector… The winding down of Anglo Irish, for example, would have been preferable to its nationalization…” In effect, the previous Government made Anglo systemically important by rescuing it. If there ever was a better example of the medicine that kills the patient.

Economics 11/06/2010: What's going up might be also going down

Irish retail sales have surprised on the positive side, posting a 0.3% increase yoy for sales ex-motors in April 2010. Sounds impressive, especially considering this was the first yoy increase since March 2008, or over some 25 months now. But hold on to that thought of a recovery signal. Check out the charts:
Things are still very much up in the air as to whether retail sales are actually on a mend or not. The figures above plot seasonally adjusted series ex-motors. More importantly, sales in the categories that are correlated with overall household investment activities - household equipment (down 3.1% in value mom, and down 1.2% in volume mom), electrical goods (-3.2% in value mom and 2.3% in volume mom) and Furniture & Lighting (down 5% in value and 6.2% in volume) - all signal no growth in the core leading indicator of a recovery - improved domestic investment. Only Hardware, Paint & Glass category related to investment showed increases of 2% and 4.2% in value and volume in mom terms.

Interestingly, Ireland bucked the EU-wide trend in April:

Economics 28/11/2009: Net investment position, 2008

CSO released Ireland's net investment positions for 2008 yesterday. Full release is available here. My analysis of this data follows:

Table shows outflows of Irish-owned investment from Ireland to foreign destinations (negative values) and the share of each destination in total outflows. Note the significant jump in outflows to the offshore centres, which has risen between 2006 and 2007. It will be interesting to see if this trend – moderated in 2008 – resumes in 2009 in the wake of significant increase in taxation burden in Ireland. Per more detailed breakdown in CSO data, the offshore centres received only a modest share of Irish capital in the form of reinvested earnings, and virtually none in equity purchases, suggesting that most of the outflow to these destinations was in form of business investment and cash.
Another interesting feature of this data is that significant outflows continued to the UK in 2008. Margin calls? These related to equity purchases and reinvested dividends and a significant uptick in ‘other capital’ outflows (margin calls covers on buy-to-let and other risky investments covers?).

Over the same period of time, outflow of investments to the US has fallen off the cliff in 2008. Equity purchases in the US peaked in 2007 at almost 5 times the levels of 2006 and then collapsed to a quarter of 2007 levels in 2008. Someone was buying into the top of the bubble in the US stock markets… Meanwhile, reinvested dividends remained relatively stable. Other types of capital have fallen off the cliff from almost €3 billion in 2006 to €746mln in 2007 to €77mln in 2008. Given that the US property prices peaked in 2006, this also suggests that we were buying at the top of the market there.

Table above shows inward investment inflows to Ireland. Negative values imply that foreign investors took out net amount of capital from Ireland. Offshore centres sent in about as much as 40% of the inflows from entire European area. Any alarms ringing at the Financial Regulator’s office? Notice dramatic swing from net inflows to net outflow vis-à-vis Lux and the Netherlands in 2007-2008? Equity and other capital outflows dominated here. Tax optimization in action, especially on capital taxes side.

Amazing figures from the US. Between 2007-2008, a surplus of inward inflows of €15.2bn swings into a deficit of net outflows of €14.6bn – a spread of €29.8bn or 17.4% of 2009 GDP! Interestingly, equity and reinvested earnings were still in net positive in 2008, and going strong, so the massive net outflows were the result of something else. Capital flight? Deposits crunch? Losses taking?

Net deterioration in our inward investment position between 2007 and 2008 was over €31.7bn or -18.54% of our 2009 GDP. Net improvement in our inward investment position between 2006 and 2007 was €13.63bn or +7.97% of our 2009 GDP. Massive volatility even for a small open economy, but what does it tell us about Government's idea that Ireland Inc will be rescued not by our own actions, but by foreign investors coming back to our shores?

The totals suggest that Ireland has bled a massive €36.8bn worth of investments (equivalent to 21.5% of our 2009 GDP) out of the country in 2006-2008 alone. This hardly accounts for the full extent of deterioration in the capital values of the remaining investments by foreigners in Ireland and Irish own investments abroad. But even without taking into account our current crisis, at the peak of our markets valuations in 2006-2007, we were hardly generating much real growth out of our own and foreign investments into the country. Wonder why? Me too.

Economics 24/08/2009: Wealth effects in Ireland and Wholesale Prices

Mountain air and thunderstorms are conducive to light reading, so I was wading through an interesting and sweetly short ECB paper from May 2009, titled “Euro Area Private Consumption: Is There a Role for Housing Wealth Effects”.

The paper looks at a number of Eurozone countries – excluding the wonderland of Ireland (so it provides conservative estimates for the wealth effects) – to find that the marginal propensity to consume out of financial wealth (MPCF) in the Eurozone ranged between 2.4% and 3.6% on the aggregate. The MPC out of nominal housing wealth lies between 0.7 and 0.9%.

Re-parameterizing the model for the case of Ireland,

• financial wealth declines since 2007 peak imply that Irish consumption should have fallen by ca 1.9-2.9%;
• housing wealth declines add another 0.35-0.45% to the consumption losses;
• while negative equity effects (assuming 20% of households in negative equity) subtract further 0.69-1% off our consumption.
• So the cumulative effect of recent wealth losses should be in the area of 1.45-2.1% of consumption expenditure.

The above figure does not account for the fact that in most cases our debt levels used to finance financial and housing wealth acquisitions were not diminished over the last two years. Factoring this in, net decline in consumption expenditure should be around 1.7-2.6% in permanent terms.

This goes some ways to highlight the fact that this economy is not running a tax-shortfall-driven deficit on public accounts – we are now increasing public consumption amidst permanently shrunken private consumption. Given that Ireland’s net current Government expenditure is projected (by the DofF) to rise 17.64% between 2009 and 2013 (from €46.365bn to €54.546bn) while the expected cumulative loss in private consumption is expected to total 8.8-13.7%, the wedge between private and public consumption growth in the crisis years is likely to be around 17.5-22.5% of private consumption. And that is before tax increases and future bonds financing burdens are factored in. In other words, tax us some more and we will withdraw all unnecessary consumption from this economy. If we were a land-locked Luxembourg, I doubt there will be many non-public service workers still living in Ireland after that.

And per the latest wholesale price indices release from CSO, here are few charts.

First, exporting vs home sales prices – a clear return to the previous trend of widening gap. Exporters are still suffering while domestic sectors are running improving pricing conditions. A brief period of convergence in November 2008 – January 2009 has now been firmly replaced by a renewed bout of falling export prices and rising domestic ones. Unfortunately, CSO is not providing actual raw data on these series this time around, so no more analysis is possible for now.

Second chart is dealing with manufacturing prices and growth rates (yoy and mom). Deflation continues here and has accelerated in July relative to June. Month-on-month changes are really telling the story – June improvement is still visible, but is being erased. Note monthly range for July 2008-July 2009 being negatively sloped, as contrasted with July 2007-July 2008. Plotting monthly indices by year shows that seasonality is not as important here and that 2009 is pretty much all about traveling down a steep deflation curve that started in November 2008.

S&P's downgrade for Ireland

Here are my two cheers to S&P for today’s note on downgrading its outlook on Ireland –
One Cheer: for getting there late (although it is better than never), and
Another Cheer: for getting it so dramatically wrong, their ‘pessimism’ actually sounds like exuberant optimism when compared with reality.

Here are the details (all quotes are from S&P statement):

“Standard & Poor's Ratings Services said today it revised its outlook on the Republic of Ireland to negative from stable, on what we view as mounting fiscal pressures and deterioration of key economic sectors. At the same time, the 'AAA' long-term and 'A-1+' short-term sovereign credit ratings were affirmed. Standard & Poor's also affirmed its 'AAA/A-1+' ratings on the debt programs and instruments of those Irish banks where they are guaranteed until maturity by the Republic of Ireland.”

Hmm, let me get this right – Irish Government debt is ranked above junk level. Irish Government debt underwrites junk corporate debt of our banks, that in itself is over x2 times Irish GDP or over x5 times Government share of the entire Irish economy. So: 1:6 is AAA/A-1+, while 5:6 is something along the lines of B to CCC quality, absent guarantee. But the whole thing is AAA/A-1+... This does look to me like the logic of securitized mortgages ratings of the good old past – no weighted average can achieve this risk pricing. A BBB for Ireland Inc and B/CCC for the banks sounds to me like a better mark.

"The outlook revision reflects our opinion of the rising economic policy challenges stemming from the contraction of the key housing, construction, and financial sectors, which have spurred many years of strong economic growth and fiscal consolidation," said Standard & Poor's credit analyst Trevor Cullinan. …We have observed that general government debt levels also increased substantially between 2007 and 2008, by more than 16% of GDP, as a result of the widening deficit, although a substantial portion of the increased indebtedness (10% of GDP) remains in Exchequer cash balances as a liquidity buffer.”

This is fine, with a small caveat – all these trends were more than pronounced around the end of Q3 – the time by which the likes of our General Government Deficit has recorded expansion of 6% (Q1 2008 on Q1 2007), 10% (Q2 2008 on Q2 2007) and 12% (Q3 2008 on Q3 2007), the economy was in an official recession (2 quarters running) and the housing prices have been falling for some 11 months! S&P's ‘better late than never’ is hardly a useful time-line from the point of view of bonds investors who subscribed this week to another pile of Irish paper. Is S&P actually timing its notes after the issues are placed or was timing some pure coincidence?

“We note that the government has also extended guarantees to seven domestic credit institutions through Sept. 29, 2010, increasing general government guaranteed debt to an estimated 228% of GDP in 2009. Banking system exposure to the property and construction sector of about one-third of total loans (excluding interbank lending) suggests a high risk of asset deterioration at these institutions.”

Not a word on banks recapitalization scheme costs here - worth another 5-7% of GDP? Or the fact that the Government is planning to tap the markets for some €20bn in fresh debt in 2009 (possibly €30bn – should recapitalization scheme materialize and should the government redeem April 2009 bonds)? Or the fact that GDP is not something that should be used to peg our credit worthiness on, as GDP/GNP gap stands massive and rising?

As per 1/3 loan books exposure to property and construction sector… Anglo-Irish Bank’s annual results (December 2008) show 87% loan book exposure to Property & Construction. Bank of Ireland (as of July 2008) reported 26% exposure to Property & Construction, plus 44% to Residential Mortgages, so total BofI Property exposure was 70%, with some of the 'Other' loans secured against Property & Construction assets. AIB – also July 2008 figures – showed 37% exposure to Construction & Property, 23% to Residential Mortgages, giving it a grand total exposure to Property & Construction of 60%. Given that the rest of the sector (consider a relative banking minnow of IL&P - Construction & Property exposure of 6% of the banking book and 88% to Mortgages, yielding implicit exposure to Construction & Property sector of 94%) is even more entangled in Property & Construction lending, would the maths genius in S&P who did their sums please raise his hand?

“The ratings on the Republic of Ireland are supported by what we view as the flexibility of its economy, high per capita income, and a favorable demographic structure. The government's commitment to contribute 1% of GNP per annum to the National Pensions Reserve Fund (NPRF), in our opinion, reduces the fiscal burden of population aging more than in some other European countries. However, the government is expected to use NPRF assets to assist in funding an estimated EUR10 billion (5% of GDP) recapitalization of its domestic banking sector.”

Now, this is a pure hogwash.

Let’s start with NPRF. The Fund is hardly a credible buffer for pensions time bomb in Ireland for two major reasons: (1) the Fund was established to pay Public Sector pensions obligations and, as a residual, general government pensions (without stipulating the level of payment guarantees); (2) this year’s pension funds performance has wiped out at the very least 40-50% of the entire pensions provisions in the private sector. In other words, from the point of view of the private sector employees, NPRF is a tax on their output, providing no legal entitlement to a pension benefit. Full stop.

What about the perverse logic that in order to contribute to NPRF in 2008 and 2009, the state will have to borrow funds in the open markets! Is S&P implicitly promoting an equivalence of 'borrow expensively, to save cheaply' policy?

The hodge-podge about the ‘flexibility of Ireland’s economy’ is ridiculous. It was more than aptly illustrated by this week’s events in Limerick, where a quasi-closure of one multinational factory is likely to lead to a collapse of the regional economy. Our own National Competitiveness Council does not subscribe to the myth of some magic ‘resilience’ of our economic model. S&P would be better served to look at composition of our GDP and GNP to discover the fact that Ireland’s economy is severely restricted in its flexibility by: (1) excessive concentration of exports in the multinationals-controlled sectors, (2) atavistic and cost-inelastic structure of our labor markets, (3) one of the highest cost bases in business support public services in the EU27, (4) shortages of skills, and (5) over-reliance on personal consumption and construction in our domestic economy, and (6) excessive public sector waste.

One quick note on demographics: our 'demographic' benefit only works assuming static migration flows. Strong net emigration (in line with, say, 1980s and accounting for adverse selection bias in skills/ work experience) can easily shift our demographic pyramid to resemble EU average.

"The negative outlook reflects our view of the likelihood of a downgrade if ongoing fiscal measures to recapitalize the banks and boost the economy fail to improve competitiveness, diversity, and growth prospects, thereby leaving a more difficult-to-manage debt burden," said Mr. Cullinan. "Conversely, the negative outlook could revert to stable if the government's strategy is successful and allows public finances to return to the stronger position of recent years.”

Oh, mighty! What ‘ongoing fiscal …boost’? What Government strategy? This Government has not produced a single fiscal stimulus package to date! More than that, the Government is actually looking into cutting fiscal spending (something that it must do), without expressing any intent to roll public spending savings into fiscal stimulus (something that it should have pre-committed itself to doing long before it piled on expected debts through banks' guarantees and recapitalization measures).

Just read this from the Department of Finance:
"Investment in capital projects to enhance Ireland’s productive capacity has been retained at a very high level, of the order of 5 per cent of GNP... given the extraordinary economic and financial circumstances impacting on all countries, including Ireland, this level of investment, which is now being totally funded from borrowings, will provide a significant fiscal stimulus in these difficult times."

In other words, don't bet on any real fiscal stimulus - after all, recall that this 5% of GNP (not GDP) package is the same one we had since the passage of NDP two years ago - in late January 2007!

In short, S&P’s note is one of the most bizarre assessments of Ireland’s credit worthiness I’ve seen since the Building Ireland's Smart Economy flop (here). Can someone from their team actually get engaged with those of us who are on the ground next time?

The latest plan is a 'white elephant'

The latest Government plan for crises-ridden Irish economy is, letter for letter, a rehashing of past clichés and a pandering to the minority interest groups in politics and business.

When the cornerstone crumbles

Perhaps the most frustrating in the entire document is its centre piece – the so-called €500mln venture capital fund which, according to the reports represents:
“…the key element in Building Ireland's Smart Economy... is the establishment of venture capital funds worth €500 million designed to lure innovative industries and boost research and development.” The Irish Times, December 19, 2008.

The fund will allow three US-based VC companies to invest in start-up Irish and foreign-owned IT and environmental "green tech" companies setting up here. The Government will provide up €25 million a year for 10 years and take a 49 per cent share in the investment companies. Investors will avail of a 15% tax rate on profits.

As quoted in the aforementioned article Taoiseach Brian Cowen said that:
"The aim is that Ireland becomes the world's leading location for business innovation, a country where there will be a critical mass of companies - both Irish and international - at the forefront of innovation, creating the products and services of tomorrow and well-paid quality employment."

It will do nothing of the sorts.

Poor record

This plan represents a clear lack of learning from the past mistakes. Our State’s record in acting as a venture capital investor is thin in experience and disastrous in quality.

Media Lab Europe (MLE) is one example that springs to mind. Some 8 years ago, the State decided to ride the IT bubble hysteria by dumping in excess of €35 million into an early-stage investment in a belief that government-paid provider of services to the various government agencies is the way to enhancing Ireland’s knowledge economy. Five years later it became apparent that the organization was incapable of delivering either commercial or academic value. MLE produced just 15 refereed papers (only 3 were published in the first-tier journals) between 2000 and 2005, signed up virtually no non-governmental business and clocked a mind-boggling loss on public investment.

Other high-tech state-run ‘investments’, inclusive of the public sector own IT programmes, fared equally poorly.

... and poor thinking

But last week’s plan is a true ‘white elephant’ of our economic development even if the record of this State in picking economic ‘winners’ is omitted. The plan fails on the basis of the Venture Capital sector own data across the following parameters:
(1) Timing – 10 year horizon;
(2) Sectors targeted for investment – IT and ‘green’ technologies;
(3) Type of investment – seed and early stage capital; and
(4) Size – €500 mln spread over 3 funds.

According to the European Commission DG for Enterprise and Industry (DGEI) analysis of seed capital funding, for the period of 1994-2003, 5-10 year seed and early-stage development capital funds average internal rates of return were -1.8% and 1.3% respectively. Almost exactly the same returns were recorded for the period of 1983-2003. This included better-performing US-based funds and covered the era of the IT bubble, when tech valuations reached stratospheric proportions.

European Private Equity and Venture Capital Association (EVCA) confirms the above results for more current data. As shown in Table 1, 10-year returns averaged -1.1% for the early stage investments – the same type of investment envisioned in our State plan. In contrast, development finance might have been a safer bet for taxpayers money, but considering the dire shortage of high-quality early-stage domestic firms, this would require us to “pay” established foreign firms to locate here – something that is not kosher under the EU regulations.

Table 1: Funds Formed since 1980, top quarter returns as of 31 December 2006
http://www.evca.eu/knowledgecenter/barometer.aspx?id=462

Figure 1 illustrates two major EU-wide market trends in VC investments:
(1) Fewer and fewer private funds invest in high-tech start ups (due to higher risk, lower returns to these investments); and
(2) Both the seed and start-up capital shares of total VC allocations have been falling precipitously over time.
The Irish Government plan runs precisely against these two trends.

Figure 1: Allocation of funds raised 2002-2006, €bn
Sources: EVCA and PEREP Analytics for 2002-2007 figures

Another report compiled in March 2006 by DG for Economic and Financial Affairs (DG EFA) concluded, among other things:
“As a whole, the returns produced by European venture capital funds specialising in early stage (seed capital and start-up) investment have been disappointing. …taking into account the relatively high risk of this type of investing, the IRRs recorded do not appear competitive when compared to the more predictable buyout investing. …The difference in performance between venture capital and private equity may well be the main explanation for the recent trend for European investment activity to focus on less risky buyout investment rather than venture capital.” As Table 2 shows, even accounting for distributions to investors, early stage financing simply does not pay off when compared to development stage investments.

Table 2: Cumulative investment multiples for EU funds formed in 1980-2003
Source: DG EFA 2007

What about the risks associated with the plan? Again, using the DG EFA data, as Table 3 states, European VC investments underperformed the equity indices in all instances, with exception for the period of post-bubble recession in the US.

Table 3: Public markets returns vs. VC investment

Source: DG EFA 2007

Suppose that the Irish Government fund performance matches the peak past returns for EU VC funds. This implies that at the end of 10 years period we attain a cumulative total value per €1 invested multiple (inclusive of disbursements, etc) of ca x2.9 (as consistent with vintage 1995 funds). This delivers an annualized rate of return of 6.6% or risk-adjusted annualized return of only 3.7-4.8%. This is worse than putting the taxpayers money into a termed deposit with the Anglo Irish Bank. Now, considering the business cycle dynamics, the current investment, assuming 2009 will be the last year of economic contraction in Ireland, implies a historical valuation coincident with the VC funds of vintage 2000-2001. In this vintage, the EU funds yielded a cumulative total value multiples of ca x0.8 and x0.65 respectively, giving a compounded rate of return on the planned state fund of -35% to -20%. Risk-adjusted, this implies a range of -58.3-87%.


Destroying the market

In 2006, a DGEI workshop on seed finance has concluded that “Public intervention needs to take place in a way that avoids the risk of crowding out the private sector.”

To date, Irish VC markets have been characterized by monopolistic competition with Enterprise Ireland (EI) capturing a lions’ share of total investment and private VC firms acting as a competitive minority fringe. Thus, even at the times of plenty the Irish market can hardly be described as that with sufficient demand/supply clearance. In other words, during the time of the robust entrepreneurial activity, Irish start-ups have shown only minor ability to attract private VC capital. Of course, the presence of a state lender with soft budget constraints (EI) helped to undermine domestic VC services.

This structure of the market has hardly changed to warrant a new intervention by the Irish Government. Indeed, if capitalized as planned, the new plan will deliver a re-enforcement of the already unhealthy degree of state monopoly power over the VC market in this country. In the end, there is very little difference between the Irish Department of Finance boffins picking the ‘winning’ start-ups or appointing three US VC funds to do this for them. After all, the rules of the game are fixed (remember those IT and green-tech ideals?) and the losers are known in advance (Ireland’s taxpayers and entrepreneurs).

It would have been simply better for the Government to drop the CGT to match the 12.5% corporate tax. At least this would have assured that private gains yield returns to the Exchequer, without socializing private losses.