7/6/2012: Sunday Times June 3, 2012

This is an unedited version of my Sunday Times article from June 3, 2012.

In early 2008, Brian Cowen described Ireland’s predicament with a catchy phrase ‘We are where we are’. Ever since this became synonymous with gross incompetence, epic failure and outright venality of our elites.

Fast forward to May 2012. In the heat of the EU Referendum campaigns, both Government parties have paraded their up-beat assessments of the economy, their own stewardship and achievements. The factual record of the current Government on economic policies is only slightly ahead of that attained by their predecessors.

Don’t’ take my words for this. Look at just where exactly ‘we’ – Ireland – ‘are’ in the crisis after a year of stewardship by the Coalition.

We are officially in a recession. Both GDP and GNP have shrunk in the last half of 2011 and all indications are, growth is unlikely to have returned in Q1 2012 either. Should Ireland post another quarter of negative growth, we will join the club of Italy, Cyprus, the Netherlands and Portugal. This select group of the euro area countries have managed to record GDP declines in three consecutive quarters since the end of June 2011. For Ireland, this abysmal economic performance comes on foot of the overall 17.6% decline in GDP and 24.2% drop in GNP since 2007 peak through the end of 2011. This didn’t stop this Government from declaring, as its predecessors did, various ‘turnarounds’ and ‘improvements’ in the economy, as a part of their credit, even though so far, the actual record of this Government on growth is negative. Since the Coalition came into power, GDP grew just 0.7% and GNP shrunk 4.1%, investment is down 12.8%, personal consumption fell 1.6%, while expatriation of profits by the MNCs operating here rose 24.6%.

Despite accelerating emigration and ever-rising numbers of unemployed being reclassified as engaged in state-sponsored training programmes, the latest unemployment remains stuck at 14.3% exactly identical to that recorded a year ago. In May 2011, there were 444,400 people on the Live Register and 71,231 in various state training schemes, this month these numbers were 436,700 and 82,331, respectively. Year on year, numbers at risk of underemployment rose 3,131. The Government has claimed that it has helped creating some tens of thousands new jobs, ranging from MNCs-supported ‘smart economy’ workers to hospitality sector. In reality, once training programmes are added, the numbers of those drawing unemployment supports rose 3,400 over the tenure of this Coalition.

Not surprisingly, consumer demand – accounting for 52% of our overall economic activity (in comparison, net external trade in goods and services accounts for less than one half of that figure) – is shrinking. Hammered by the push toward debts deleveraging, higher taxes, losses of income due to shrinking earnings and strong inflation in state-controlled sectors, Irish consumers are running away from the shops. Retail sales, ex-motors, have fallen 2.3% year on year in April 2012 in value terms and 3.8% in volume. This marks the fourth consecutive month of dual declines in volumes and value and the steepest rates of declines since October 2011 for value series and since May 2011 for volume. Things used to be getting worse at a slower rate in retail services sector. Now they are getting worse at a faster rate.

Banks reforms are truly not paying off for the Government. The latest banks lending survey for April 2012 shows that Irish banks have uniformly tightened, not relaxed, lending to enterprises in Q1 2012, compared to no change in lending standards recorded in Q4 2011. Things have not improved in consumer lending either, with mortgages lending running at just 5% of the levels seen during the peak. Meanwhile, costs remained the same in Q1 2012 as in Q4 2011 across all sources of funding. Following the estimates of foreign analysts, mirroring this column’s earlier prediction, the Central Bank now quietly admits that more funds will be required to offset rising mortgages arrears. More capital will be called on to bring Irish banks balancesheets to Basel III standards in years to come.

We are nowhere near the end of the crisis relating to housing markets. In Q1 2012 the overall level of mortgages at risk of default or already in default has reached 15.3% of the overall outstanding mortgages, 19.3% of all mortgages balances. This compares to 11.1% for levels and 13.6% for balances a year ago.

The game of extend-and-pretend drags on, as the Government publicly makes bombastic pronouncements about ‘stabilization’ and ‘reforms’ achieved in the sector, while reluctantly admitting that mortgages books are in a mess. The strategic response to this is the Government’s hope that the EU will be forced to mutualize banks debts, shifting them off the books of the state.

Housing markets continue to contract and commercial real estate values are still declining. The latest Residential Property Price Index for April shows that overall national property prices are already 50% down on the peak. Two consecutive monthly rises in Apartments and Dublin sub-markets can be interpreted as either a nascent stabilization, or one of the already numerous ‘false starts’ soon to be followed by renewed prices contractions. Take your pick, but either way we are way off any real recovery here.

Since about mid-2011, the Government has been committing a twin fallacy of referencing our bond yields moderation as a sign of ‘improved confidence’ in its policies. In reality, after massive LTROs that saw billions of euros pumped by the Irish banks into Government bonds, Irish yields are now back at the levels seen in January 2012. Over the last 18 months, the Troika programme has seen billions of Irish bonds taken off the market. This, alongside with the lack of new issuance, has meant that our bonds yields no longer provide a signal as to the expected cost of Irish Government borrowing. Since April 2011, the volumes of Irish Government bonds held by foreign investors have fallen by some 20% - the third steepest rate of decline in Europe after Greece and Portugal. The rate of foreign investors’ exiting Irish Government bond holdings has accelerated once again in the last 2 months. Year on year, Irish Credit Default Swaps spread over Germany is up almost 8% and this week our CDS reached 720bps.

The fact is, even by the above metrics, the current relative stability of our fiscal, financial and economic conditions is being supported by exceedingly optimistic assessments of our future growth and fiscal potential. Currently, Ireland runs the highest level of Government deficits in the euro area. Even if we stick to the EU-IMF adjustment programme, based on Department of Finance projections, in 2015 Ireland’s structural deficit will be the second highest amongst the old euro area member states. And to get to this unenviable position, we will need to carry out some €8.6 billion worth of new cuts between Budget 2013 and Budget 2015, taking more than €9,500 in additional funds out of working families’ budgets.

We are where we are – in a worse place than we were a year ago. Given the rates of economic destruction experienced since the onset of the crisis in 2008, this is doubly damaging to the claimed Government credit of reforms. Economics of the crises tell us that, on average, the harder the fall, the faster is the rise in the recovery. Ireland seems to be bucking this historical trend with our L-shaped recession to-date.

CHARTS:

Irish Economy: a longer view

Yesterday I was asked to give a quick talk to the Marketing Institute - at a lovely breakfast gathering - on my view of Ireland's economic prospects. Here are the notes from my speech:

First, 'we are where we are'...

Fiscal problem - the real crisis:

• 2013= Euro 131bn or 91% of 2009 GNP, Euro 47,640 per adult person in debt. We will be spending 21.1% of our 2009 tax revenue servicing this debt – these are DofF projections-based estimates without Nama.
• With Nama up to 204bn in 2013, 140% of 2009 GNP or 74,200 euro per adult person. We will be spending 33% of our 2009 tax revenue on servicing the debt.
• In effect, Ireland’s debt servicing charge alone will be bigger than the entire health and social welfare bill today.
• It pays for three things - services (some we need, others we can do without), social welfare (mostly excessive in levels) and public sector wages and pensions (absurdly excessive burden). Not a hell of a lot for the loot they collect.
  

Implications:

• Credit conditions will remain very tight in the country so old model of credit-fueled growth is out of the window.
• Households spending will be down, savings will rise, but capital will outflow abroad as banks lending abroad will increase.
• There will be net emigration out of Ireland and inward migration into Dublin.
• Higher taxes are here to stay.
• Opportunities will be limited on public and private sectors sides.
• Irish businesses will be locked in a zero sum game where domestic growth of one company will require domestic losses in another.

Nama problem: a sound of vaporized wealth

• The net cost is likely to be staggering – ca €6,000-12,000 per working-age adult person under benign assumptions.
• Economic cost will be even higher due to zombie banks, zombie developers.
• Even if Nama improves credit supply (doubtful for several reasons) it will destroy credit demand (no deleveraging is possible for the households).
• Investment will be limited to firms with international markets exposure, which means business models will have to change.
• We will be exporting brighter younger people, to be replaced by marginally brighter than the remaining Irish workers younger foreigners from the fringes of Europe and outside the EU – this means our business models will have to change. New consumers will spend minimum in Ireland and will expatriate more cash out in fear of immigration policy reversals and rising nationalism.
• Public sector will remain unreformed, if slightly demoralized, by failed efforts of introducing small reforms. Which means our business models will have to change for all those who relied on public contracts.
  

Economy's problems: dead end in sight?

• What is our ‘next big thing’? Do you know? I can’t see one.
• Is it ‘knowledge economy’? Not likely – late to the races, high taxes, wrong taxes, power rests with entrenched Social Partners (older, non-productive, fearful of competition). We over-rely on Government sponsored research. Private sector in Ireland is adaptive, not creative, which means it does not want to waste money on longer-term research projects.
• Knowledge economy will be happening in only a few bright spots: international finance will be back (can you leverage anything to get into this field?); few internationally traded services (TCD, UCD in education, some smaller education players; may be some private medicine, though unlikely; legal and tax services – but only domiciling into Ireland. One big and growing bright spot might be in MNCs shifting more into traded services areas (IBM model for some, start-up Googlelites, Facebookers etc).
• Domestic economy will see decline of the Irish Brands – we will be more Anglocized in terms of our consumption patterns, especially if Northern Ireland continues to open up to business.
• Is the future a ‘Green economy’? well, sort of – only with much fewer wind mills and other traditional ‘green’ production firms. Instead, there is room for using our countryside much smarter than we’ve been doing so far – tourism, smart and recovery health tourism and work-and-play tourism have some future, if we can clean up our act on bungalow blitz and passage rights with farmers. Also, smaller boutique producers of ‘green’ agricultural products have a future. But these are all small fry to sustain real growth. Spirit of Ireland is a good initiative, but will it fly or will ESB cronies shut it down?
• On house prices and property prices: peak to trough fall of 50-60% on average. Equilibrium, or long-run prices should be at 3.5-4 times average income. This roughly means 210-240,000 per house. This will be our long-time average. Trough will undershoot this target, so we can see 200,000 tested.
  

Business environment: exit the stage

• Indigenous firms will not be looking at higher margin activities, e.g strategy and market expansion at home.
• Companies will be retooling to grow abroad.
• Europe will continue pursuing regulated markets model – can we get any value out of this? Not likely – loads of competitors closer to the feeding trough and loss of our own agility can spell a disaster for out incoming FDI.
• What do businesses need to grow in this environment – step out of the shell of ‘we are Irish, we are European’ and go for ‘we can bring you into Europe, help you grow in here and keep you as a happy client’ – don’t forget to translate this into Chinese?
  

Alternatives to a slump: Doing the right thing

Reform public sector and policymaking: Introduce separation of payer and provider in public services. Let the state pay for access to service while we, the private sector, provide such services – growth opportunity space is converting some 20-25% of our GDP into world class competitive services and growing them by adding non-public customers.
Examples:
- Medical tourism
- Education
- Legal domiciling
- Logistics and distribution services
- Outsourced sales
- Marketing and advertising outsourcing?

Reduce the size of public sector and use this reduction to cut taxes on personal income at the upper margins. This introduces proper incentives for investment in Human Capital. It also feeds growing education sector that is actually productive.

Eliminate reliance on outsourcing bodies (Quangoes, FAS, Forfas and Social Partnership) in setting public policies. Rebate savings to taxpayers, but also force more direct democratic interactions between people and policies. Require that best practice analysis and economic feasibility (including environmental and social impact assessment) must be performed for any Government ‘investment’ – this improves quality of investment and returns.

Ireland as Western Hong Kong model

Make public procurement and salaries and wages costs transparent – publish them on the web.

Introduce Land Value Tax – infrastructure returns, reduced speculative holdings of land.

Abandon national spatial strategies – focus on Dublin, Cork, Galway and Limerick. This simply reflects the reality of where growth will be concentrated.

Reform immigration policies: we will still depend on inflow of talented foreigners, but we must incentivise these flows:

• Create a meaningful Green Card – giving people full rights (save for voting) and allowing them to travel visa-free across the EU (Schengen plus UK). Green Card should be issued for 1 year, then 3 years, then permanent.
• Allow no access to welfare of any kind for the first 5 years of residence for all foreign nationals. Sign bilateral agreements with other EU states whereby Irish Government will as EU states to pay for their citizens’ access to social welfare and unemployment assistance and in exchange Ireland will assume provision of those services for Irish citizens abroad.
• Have language and educational/experience – tested system of admissions (not a sole route for entry, but one of them).
• Streamline citizenship naturalization to reduce red tape. Access to naturalization should be allowed on the points system basis – number of years in residence in Ireland, having Irish family members, employment type etc should add points and speed up both naturalization eligibility and the processing time to naturalization.
  

Reform bankruptcy and directors laws:

• We must allow those who try and fail to get up back on their feet, so personal and business bankruptcy restrictions should apply for 1 year at most, the record of bankruptcy should apply only for 3 years. It should be fully cleared after 3 years.
• Stop the idiotic practice of pursuing people personal assets in collection of mortgage arrears.
• Directorship disqualifications must be reduced to cases of clear abuse.
  

Reform regulatory systems:

• Link regulators pay and pensions to their performance in office – assessable by the independent review board. If we pay them well, they should perform well.
• Reduce the number of regulators – does a small-town economy really need a Taxi Regulator? a SMS Regulator? and so on.
  

Reform banking:

• Most of reform will come from abroad – EU, G20, Basle III. Most of these reform will be painful and costly – Nama Squared?
• Domestic reforms must include:

1. Breaking a cozy ‘Old Boys’ cartel between banks and other elites. Sadly – we have no record of doing this even after all the banking scandals of the past;
2. Introducing more competitive domestic banking by reducing market shares of Irish banks – sadly, we have no record of doing this either;
3. Using Nama to bring more transparency into Irish banking – sadly, we are doing the opposite.
   

Hope is in a short supply, treat it carefully. We need some serious drastic changes and these will have to take place at the head of the table.

Economics 25/06/2009: Unemployment and IMF

While many of you are wondering where is my comment on last night's IMF report, I must ask you for your infinite patience - it is forthcoming in this week's Sunday Times and I will be posting more on the issue over time.


In the meantime, the US Bureau of Economic Analysis (BEA) reports today that the real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 5.5% in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to final estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3%.

I can see our strategy to wait for Americans to turn around working... thanks to the Irish Government tough choices on policy side, US GDP contractions are flattening out. Happy times are just around the corner.

Of course, one cannot suggest that the Irish Government is not doing more than just help the Americans in their troubles. Indeed, hat tip to BL, Politics.ie have the following itinerary for our Dear Leader of Offaly, Knight of the Bogs and Lord of the Bord Na Mona Mansions:
23.06.09:

• Brian Cowen attends the official re-opening of Shinrone National School, Birr, Co. Offaly
• Brian Cowen raises the First Green Flag at Coolderry Central School, Birr, Co. Offaly; and
• Brian Cowen attends the Official Opening of Isotron Ireland’s new Electron Beam Sterilisation Facility, at Tullamore, Co. Offaly

Of course, Mary Coughlan, the Grand Dame of Diplomatic Etiquette and the Lady of Jobs Announcements Junkets was equally busy jet-setting across the nation to announce jobs:

• 45 at Boston Scientific plant in Galway (after cutting 240 jobs in Galway last August and as another motor trade company sheds 70 jobs in Galway the same day as Mrs Coughlan arrived there);
• alongside Gaeltacht Minister Eamon "Gimme More Subsidies" O'Cuiv visiting west Donegal today to assess the damage caused by flash floods (I didn't know the DETE is also responsible for emergency services in this country); but
• Flooding aside, she did have a chance to pull an unveiling string at the launch in Finnabair Business Park in Dundalk...
  

All in the day's work for Tanaiste, directly responsible for dealing with our soaring unemployment rate (on the exact day when CSO unveiled the latest unemployment data from QNHS).
Of course, neither Biffalo-Gruffalo, nor Scary-Mary are much of the IMF/Economic Policy men (women), so why not let poor rookie, Brian Lenihan deal with the opposition fire on the issue of yesterday's damming report? Afterall, as the US data shows, things are already getting better (by getting worse at a slightly slower pace than before)... "The heart attack patient has no pulse, Doctor," shouts the nurse. "Excellent, things have bottomed out then," retorts Dr Biffalo, "Pints!"

Economics: 15/05/09: Ned 'Homer' O'Keeffe & ESRI's latest trip

So we have Ned O'Keeffe as Irish Politics answer to Homer -
except the former's daftness is actually intended as political and economic view points... read here...

"What has Tesco offered us since they came over to Ireland?" said Deputy O'Keeffe. "I think we would be better off if Tesco were to leave Ireland altogether. Their absence from the Irish market would be taken up by other supermarkets who would fill the gap and hopefully it would lead to less exploitation of Irish food suppliers. We’ve already seem the damage that foreign banks have done to Ireland and how the Irish banks were forced to make up for their mistakes. Well the same could happen in the retailing sector with the foreign retailers such as Tesco ruining the Irish supermarket industry and putting thousands of people out of work around the country", Deputy O'Keeffe concluded.

This is either delusional or clinically mad. And it comes from a sitting TD. In fact, the statement is so historically, economically and socially illiterate, Mr O'Keeffe deserves no comment on this blog other than one word: FRIGHTENING!


And in case you are not scared enough by Ned 'The Belching Brain' O'Keeffe, look no further than the latest trip-to-the-light-fantastic from ESRI: Recovery scenario for Ireland in the medium term, calling for 6.5% GDP growth. Yes, you are reading it right - 6.5%!

How did they got so high? Well, they estimated that Irish potential GDP growth post-crisis will be 3.0% (down from their previous estimate of 3.6%). Then, they slapped on top of this an additional 3.5% to account for the severity of the downturn we are currently experiencing. So the logic is - the further you fall in a recession, the steeper will be the climb on the way up. Ah, if only the world evolved according to the ESRI model.

Per IMF earlier studies (including the one I covered in several previous posts and in my column in Business & Finance), current recession, globally and in specific countries, like the US, is likely to lead to a flat-line recovery in output. But don't trust my words - see in the excellent note from NCB's Brian Devine (here):
So ESRI is in effect assuming that Ireland will be unique in the world in experiencing stronger recovery post-crisis than other economies, including those that will drive Irish recovery - i.e. the US and UK.

Alternatively, you can read ESRI's 'forecast' as being driven by the rate of FDI inflows into Ireland outstripping in the rate of growth the US/UK domestic capital investment expansion post recession 2:1.

As Brian put it in his Friday note: "The ESRI have assumed that this catch-up process will cause Irish economic growth to average 6.5% over the period 2011-2015. We would be highly cautious of this growth rate because of: a) The difficulty in measuring potential output especially in light of the current shock to the domestic and global financial system. b) The uncertainty surrounding the pace of global growth, again because of the difficulty in assessing the potential output of our main trading partners arising from the damage to the global financial system. c) The uncertain effects on consumption of further tax hikes. We also believe that consumption will remain subdued because of the rise in the level of real indebtedness."

Well argued, although I would have put it in less polite terms.

Per NCB note, the summary of ESRI 'forecasts' and NCB latest forecast, alongside with my own estimates are shown in the following table:
The difference between NCB's forecast, my estimate and ESRI's absolutely acid-sharp predictions is in assumptions...

As NCB note explains: "The conventional view of economic growth is that business cycle fluctuations in GDP represent temporary deviations from trend. In other words the economy eventually returns to a path determined by the potential of the economy. It is not abundantly clear that the current deviation from trend is transitory in nature. In other words it is quite possible that the problems in the economy are more structural in nature i.e. there has been a permanent loss of output relative to previous potential. The ESRI have acknowledged this and lowered the potential growth rate from 3.6% to 3.0% over the period 2005-2020 (driven by a significant part of the capital stock being rendered obsolete, the increase in taxes, the risk premium on borrowing and the reduction in global output potential). As a result of the current recession the ESRI estimate that there will be a permanent loss of the level of output relative to previous potential of 10%."

Ok, but... is 3.0 a relevant figure for the future? What reasons can ESRI bring about to set our potential growth rate close to the US and well above our main Eurozone competitors? Superior education system? Super-human entrepreneurship drive? Low cost base? Low tax rates? Fit and efficient public sector? Effective and pro-market Government? Workers who are accustomed to giving that extra effort and not expecting to be paid for it on the double? Competitive domestic service providers ensuring low cost of doing business in Ireland? Not likely. Shamrocks planted on a White House garden patch from the last Taoiseach's visit for Paddy's Day? More like it.

But here is more from NCB note: "As the ESRI note “In considering how the Irish economy is likely to exit from the current recession the key lies with the timing and nature of a world recovery.” Most of the world’s economies are forecast to grow at rates close to potential over the period 2011-2015 in the ESRI forecast." So why, again, does the ESRI assume that Irish economy will grow at more than double its potential GDP?

NCB also highlights timing issues in ESRI forecast: "Despite the fact that the pace of the decline in global downturn is likely behind us ...things are only getting less worse not better and the outlook remains highly uncertain, with the possibility of policy error large. The ESRI do take this into account by running an alternative scenario in which global growth does not recover until 2012 – in this case GDP growth in Ireland averages 5.5% over the period 2011-2015." So feel free to wonder - the world will still be in a recession in 2012, but ESRI's Ireland will be looking at a growth of 5.5% pa over 2011-2015? Let's take it apart: suppose 2012 the world is still in a recession, with growth of -1% - for the sake of an assumption. In 2011, obviously, things wouldn't be much better either, so let's say GDP growth is at -1.5% then. Now, to post average growth rate of 5.5% over 2011-2015 as ESRI predicts, Ireland would have to grow at a cumulative compounded rate of 34% between 2013 and 2015, or at an average annual rate of 10.25%! The ESRI use this as their pessimistic scenario...

So why are these unrealistically high numbers? Why now? Why from the ESRI? We can only speculate.

NCB's note says: "We think the greatest domestic risk to economic recovery is that the fiscal consolidation which has begun is not seen through or that taxes bear even more of the adjustment than currently envisaged (ironically the ESRIs document could halt the process of adjustment as unions/ government point to the fact that the economy is forecast to average growth of 6.5% in the future). This would have a major knock effect on consumption, competitiveness and borrowing costs and as such GDP growth."

That is, as far as I can understand it, a hint at something that I completely agree with. ESRI is a quasi-Governmental organization with no real independence in sight. In fact, what passes for 'independent' thinking in the ESRI's usual policy work is a mix of Labour's leftism in social policy department and Garret Fitz FG's legacy in taxation thinking (i.e the inherent inability of the ESRI to actually think rationally about tax burden and the damage it does to our economy). Hence, ESRI saying today that 'look - things are going to be just fine in couple of years' can be interpreted as their masters' signal to the unions and the social partners that the discomfort they might feel to be will be rewarded out of the spoils of the growing economy once again tomorrow. The timing of this rosy forecast - close enough to the elections is also, at the very best, an unfortunate coincidence.

Which brings us back to NAMA - why isn't the Government pre-committing itself to disbursing NAMA proceeds (if any gains occur) in the future to the taxpayers? Why isn't it ringfencing these proceeds? Perhaps, the NAMA upside is being held back to pay off the unions in the future through a compensatory wages increases after the crisis to the public sector workers for the income reductions they have suffered? or perhaps such a commitment has already been made? After all, the Bearded Men of the unions are not exactly fighting against NAMA, are they?..